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Event Sponsors
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Keynote Speaker - David WassermanThe U.S. House Editor of The Cook Political Report
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Year Ahead 2019: Turning Points
December 2018
Year Ahead 2019: Turning Points
Jason Draho, Ph.D.Head of Asset Allocation AmericasUBS Chief Investment Office GWM
This report has been prepared by UBS Financial Services, Inc.Please see important disclaimers and disclosures at the end of the document.
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For the bull market, age is just a number
• The US economy is humming…
• …but global growth has slowed, though it's still solid
• While the cycle should continue for a while…
• …it's highly uncertain how it will evolve, with many potential turning points
• After the market sell-off, equities aren't expensive
• Thus, this is a bull market correction, not an ending
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Growth slowdown or something worse?
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The US economy is humming…
Source: UBS Investment Research, UBS, as of 10 May 2018Source:, Bloomberg, UBS, as of 29 November 2018
The ISM Purchasing Manager Index (manufacturing) is still near multi-decade highs
30
35
40
45
50
55
60
65
70
81 85 89 93 97 01 05 09 13 17
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…with low chance of recession in the next year
Source: Bloomberg, UBS, as of 8 November 2018
New York Fed probability of recession 12 months forward, in % (recessions are shaded)
0%
20%
40%
60%
80%
100%
1965 1975 1985 1995 2005 2015
Average reading 12 months before recession
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Slowing global growth has raised concernsPurchasing Manager Index surveys in developed and emerging markets
Source:, Bloomberg, UBS, as of 9 November 2018
49
50
51
52
53
54
55
Jan-16 Jul-16 Jan-17 Jul-17 Jan-18 Jul-18
Global PMI: Manufacturing Global PMI: Composite
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Big picture, the global economy is still healthy…
Source: Haver analytics, UBS, as of 8 November 2018
Global growth is at the long-run average%
Global unemployment at multi-decade low%
-1
0
1
2
3
4
5
6
7
69 74 79 84 89 94 99 04 09 14 19 Global growth Long run average (1969-2017)
4
5
6
7
8
9
10
80 84 88 92 96 00 04 08 12 16 Median global unemployment rate
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…and China is stepping up fiscal and monetary easing China easing measures taken so far this year
Fiscal Policy Monetary Policy
Consumption Exports InvestmentFour RRR cuts
(2018)
Relending and rediscounting quote
increases (June & Oct. 2018)
Support for corporate bond
issuance
(Oct. 2018)Personal tax deductions
(Proposed Oct. 2018; effective Jan.
2019)
Infrastructure spending increases
planned
Import tariff cuts on consumption goods
(July 2018)
Personal tax threshold raised
(Oct. 2018)
Export tax refund increases
(Oct. 2018)
Import tariff cuts on industrial goods (effective Nov.
2018)
Source: UBS, Bloomberg Economics, as of October 2018.
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How will the cycle evolve?
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Many uncertain factors will impact the business cycle
• Inflation
• "Overheating" in the economy
• Tariffs
• Credit markets
• Financial conditions
• The yield curve
• Interest rates
• Monetary policy
• Fiscal policy
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Inflation is at the 2% target and may overshoot…
Source: Haver analytics, UBS., as of 8 November 2018
Inflation is finally at 2%, and risingPCE inflation, '% y-o-y
Wages are finally starting to risey-o-y
-2%
-1%
0%
1%
2%
3%
4%
5%
07 08 09 10 11 12 13 14 15 16 17 18 Headline PCE Core PCE 2% Target
1.0%
1.5%
2.0%
2.5%
3.0%
3.5%
Dec-10 Jun-12 Dec-13 Jun-15 Dec-16 Jun-18
Avg. Hourly Earnings
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…but scant evidence of an "overheating" economy
Source: Bloomberg, UBS, as of 9 November 2018
US investment as a percentage of GDP (recessions are shaded)
12%
14%
16%
18%
20%
22%
1975 1980 1985 1990 1995 2000 2005 2010 2015 2020
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The impact of tariffs on trade is becoming evidentUS imports from China (goods by tariff list, 2018 y-o-y, %)
Source: US Census Bureau, UBS, as of 3 November 2018
-20%
0%
20%
40%
Jan Feb Mar Apr May Jun Jul Aug Sep
List 1 (USD 34bn) List 2 (USD 16bn) USD 200bn list Rest
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Rapid credit growth could be a problem
Source: S&P LCD, Federal Reserve, SCF, UBS, as of 31 October 2018
0
200
400
600
800
1,000
1,200
00 02 04 06 08 10 12 14 16 18
BB (or higher) B CCC NR
Total amount of leveraged loans outstanding, by credit rating$bn
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Financial conditions have tightened, but remain supportiveBloomberg US Financial Conditions Index (positive values => looser financial conditions)
Source: Bloomberg, UBS, as of 26 November 2018
-1.5
-0.5
0.5
1.5
2013 2014 2015 2016 2017 2018
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Source: Bloomberg, UBS, as of 26 November 2018
The yield curve is flattening and will invert … eventually10y minus 2y or 3m Treasury yields has been negative before previous recessions
-4%
-2%
0%
2%
4%
6%
1980 1985 1990 1995 2000 2005 2010 2015
10yr - 2yr Treasury yields 10yr - 3mo Treasury yields
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Cash now offers a competitive return, with consequencesUS 3-month Treasury Bill & Barclays Global Aggregate Index yields
Source: Bloomberg, UBS, as of 26 November 2018
0%
1%
2%
3%
4%
5%
6%
7%
07 08 09 10 11 12 13 14 15 16 17 18
US 3-month Treasury Yield Barclays Global Aggregate Yield
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Source: Bloomberg, UBS, as of 29 November 2018
Rates may not go much higher than current levelsFed Fund futures are pricing in three more Fed rate hikes by the end of 2019 Market-implied Fed funds rate, in %
2
2.2
2.4
2.6
2.8
3
3.2
Nov-18 Apr-19 Sep-19 Feb-20 Jul-20 Dec-20 May-21 Oct-21
Nov 8 Nov 29
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Monetary policy is headed to neutral … and beyond?Real Fed funds rate and r* (estimate of the neutral rate of interest) In %, recessions are shaded
Source: Bloomberg, UBS, as of 30 June 2018
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
1
-4
-2
0
2
4
6
8
1980 1985 1990 1995 2000 2005 2010 2015
r* Real Fed funds rate
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Once a recession starts, limited fiscal policy "dry powder"US U-3 unemployment rate and US Federal deficit (or surplus) as % of GDP
Source: Bloomberg, UBS, as of 10 May 2018
-12%
-10%
-8%
-6%
-4%
-2%
0%
2%
4%3%
4%
5%
6%
7%
8%
9%
10%
11%
1970 1980 1990 2000 2010 2020
Unemployment rate, left Deficit as % of GDP (inverted), right
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For now, the bull market continues
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The stock market ≠ the economy S&P 500 annual returns vs. US annual GDP growth (1947-2017)
Source: Bloomberg, UBS, as of 26 November 2018
R² = 0.0007
-50%
-25%
0%
25%
50%
-5% 0% 5% 10%
S&P
500
annu
al re
turn
Annual GDP growth
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2018 has seen a bear market … in the P/E multipleS&P 500 trailing P/E
Source: Bloomberg, UBS, as of 9 November 2018
12x
14x
16x
18x
20x
22x
2013 2014 2015 2016 2017 2018 2019
Median since 1960
2828
Global equity valuations are at or below long-term averagesForward P/E levels relative to historical averages
Source: Datastream, UBS, as of 31 October 2018
-60%
-40%
-20%
0%
20%
40%
2003 2008 2013 2018
US International Developed Emerging Markets
2929
Higher rates are the biggest drag on US equities in 2018S&P 500 total returns year-to-date, decomposed into each constituent returns
Source: Bloomberg, UBS, as of 28 November 2018
-25%
-20%
-15%
-10%
-5%
0%
5%
10%
15%
Total Return Return from EPSgrowth
Return from higheryields
Return from lower riskpremium
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Lower earnings growth in 2019, but still solidS&P 500 earnings per share, in USD; and year-on-year growth, in %
$98$104
$110
$119 $118 $119
$133
$168
+6%
+6%
+8% -1% +1%
+12%
+21%
+4%
$161
2011 2012 2013 2014 2015 2016 2017 2018F 2019F
Tax reform tailwind
Source: UBS, as of 9 November 2018
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Bull market corrections are usually a time to buyS&P 500 forward average returns
Source: Bloomberg, UBS, as of 9 November 2018
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
20%
3 mos 6 mos 9 mos 12 mos
When P/E declines > 15% in 9 mos All periods
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AppendixStatement of risk1. Equity markets are difficult to forecast because of fluctuations in the economy, investor psychology, geopolitical conditions, and other important variables. 2. Bond market returns are difficult to forecast because of fluctuations in the economy, investor psychology, geopolitical conditions and other important variables. Corporate
bonds are subject to a number of risks, including credit risk, interest rate risk, liquidity risk, and event risk. Though historical default rates are low on investment grade corporate bonds, perceived adverse changes in the credit quality of an issuer may negatively affect the market value of securities. As interest rates rise, the value of a fixed coupon security will likely decline. Bonds are subject to market value fluctuations, given changes in the level of risk-free interest rates. Not all bonds can be sold quickly or easily on the open market. Prospective investors should consult their tax advisors concerning the federal, state, local, and non-U.S. tax consequences of owning any securities referenced in this report.
3. Prospective investors should consult their tax advisors concerning the federal, state, local, and non-U.S. tax consequences of owning preferred stocks. Preferred stocks are subject to market value fluctuations, given changes in the level of interest rates. For example, if interest rates rise, the value of these securities could decline. If preferred stocks are sold prior to maturity, price and yield may vary. Adverse changes in the credit quality of the issuer may negatively affect the market value of the securities. Most preferred securities may be redeemed at par after five years. If this occurs, holders of the securities may be faced with a reinvestment decision at lower future rates. Preferred stocks are also subject to other risks, including illiquidity and certain special redemption provisions.
4. Although historical default rates are very low, all municipal bonds carry credit risk, with the degree of risk largely following the particular bond’s sector. Additionally, all municipal bonds feature valuation, return, and liquidity risk. Valuation tends to follow internal and external factors, including the level of interest rates, bond ratings, supply factors, and media reporting. These can be difficult or impossible to project accurately. Also, most municipal bonds are callable and/or subject to earlier than expected redemption, which can reduce an investor’s total return. Because of the large number of municipal issuers and credit structures, not all bonds can be easily or quickly sold on the open market.
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AppendixEmerging Market InvestmentsInvestors should be aware that Emerging Market assets are subject to, amongst others, potential risks linked to currency volatility, abrupt changes in the cost of capital and the economic growth outlook, as well as regulatory and socio-political risk, interest rate risk and higher credit risk. Assets can sometimes be very illiquid and liquidity conditions can abruptly worsen. WMR generally recommends only those securities it believes have been registered under Federal U.S. registration rules (Section 12 of the Securities Exchange Act of 1934) and individual State registration rules (commonly known as "Blue Sky" laws). Prospective investors should be aware that to the extent permitted under US law, WMR may from time to time recommend bonds that are not registered under US or State securities laws. These bonds may be issued in jurisdictions where the level of required disclosures to be made by issuers is not as frequent or complete as that required by US laws. For more background on emerging markets generally, see the WMR Education Notes "Investing in Emerging Markets (Part 1): Equities", 27 August 2007, "Emerging Market Bonds: Understanding Emerging Market Bonds," 12 August 2009 and "Emerging Markets Bonds: Understanding Sovereign Risk," 17 December 2009. Investors interested in holding bonds for a longer period are advised to select the bonds of those sovereigns with the highest credit ratings (in the investment grade band). Such an approach should decrease the risk that an investor could end up holding bonds on which the sovereign has defaulted. Sub-investment grade bonds are recommended only for clients with a higher risk tolerance and who seek to hold higher yielding bonds for shorter periods only.
Non-Traditional AssetsNon-traditional asset classes are alternative investments that include hedge funds, private equity, real estate, and managed futures (collectively, alternative investments). Interests of alternative investment funds are sold only to qualified investors, and only by means of offering documents that include information about the risks, performance and expenses of alternative investment funds, and which clients are urged to read carefully before subscribing and retain. An investment in an alternative investment fund is speculative and involves significant risks. Specifically, these investments (1) are not mutual funds and are not subject to the same regulatory requirements as mutual funds; (2) may have performance that is volatile, and investors may lose all or a substantial amount of their investment; (3) may engage in leverage and other speculative investment practices that may increase the risk of investment loss; (4) are long-term, illiquid investments, there is generally no secondary market for the interests of a fund, and none is expected to develop; (5) interests of alternative investment funds typically will be illiquid and subject to restrictions on transfer; (6) may not be required to provide periodic pricing or valuation information to investors; (7) generally involve complex tax strategies and there may be delays in distributing tax information to investors; (8) are subject to high fees, including management fees and other fees and expenses, all of which will reduce profits.Interests in alternative investment funds are not deposits or obligations of, or guaranteed or endorsed by, any bank or other insured depository institution, and are not federally insured by the Federal Deposit Insurance Corporation, the Federal Reserve Board, or any other governmental agency. Prospective investors should understand these risks and have the financial ability and willingness to accept them for an extended period of time before making an investment in an alternative investment fund and should consider an alternative investment fund as a supplement to an overall investment program.In addition to the risks that apply to alternative investments generally, the following are additional risks related to an investment in these strategies:• Hedge Fund Risk: There are risks specifically associated with investing in hedge funds, which may include risks associated with investing in short sales, options, small-cap stocks, "junk
bonds," derivatives, distressed securities, non-U.S. securities and illiquid investments.• Managed Futures: There are risks specifically associated with investing in managed futures programs. For example, not all managers focus on all strategies at all times, and managed futures
strategies may have material directional elements.• Real Estate: There are risks specifically associated with investing in real estate products and real estate investment trusts. They involve risks associated with debt, adverse changes in general
economic or local market conditions, changes in governmental, tax, real estate and zoning laws or regulations, risks associated with capital calls and, for some real estate products, the risks associated with the ability to qualify for favorable treatment under the federal tax laws.
• Private Equity: There are risks specifically associated with investing in private equity. Capital calls can be made on short no-tice, and the failure to meet capital calls can result in significant adverse consequences including, but not limited to, a total loss of investment.
• Foreign Exchange/Currency Risk: Investors in securities of issuers located outside of the United States should be aware that even for securities denominated in U.S. dollars, changes in the exchange rate between the U.S. dollar and the issuer’s "home" currency can have unexpected effects on the market value and liquidity of those securities. Those securities may also be affected by other risks (such as political, economic or regulatory changes) that may not be readily known to a U.S. investor.
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Appendix: explanations about asset allocationsSources of strategic asset allocations and investor risk profilesStrategic Strategic asset allocations represent the longer-term allocation of assets that is deemed suitable for a particular investor. The strategic asset allocation models discussed in this publication, and the capital market assumptions used for the strategic asset allocations, were developed and approved by the WMA AAC.The strategic asset allocations are provided for illustrative purposes only and were designed by the WMA AAC for hypothetical US investors with a total return objective under five different Investor Risk Profiles ranging from conservative to aggressive. In general, strategic asset allocations will differ among investors according to their individual circumstances, risk tolerance, return objectives and time horizon. Therefore, the strategic asset allocations in this publication may not be suitable for all investors or investment goals and should not be used as the sole basis of any investment decision. Minimum net worth requirements may apply to allocations to non-traditional assets. As always, please consult your UBS Financial Advisor to see how these weightings should be applied or modified according to your individual profile and investment goals.The process by which the strategic asset allocations were derived is described in detail in the publication entitled “Strategic Asset Allocation (SAA) Methodology and Portfolios,” published on 26 February 2017. Your Financial Advisor can provide you with a copy.
Deviations from strategic asset allocation or benchmark allocationThe recommended tactical deviations from the strategic asset allocation or benchmark allocation are provided by the Global Investment Committee and the Investment Strategy Group within CIO Wealth Management Research Americas. They reflect the short- to medium-term assessment of market opportunities and risks in the respective asset classes and market segments. Positive/zero/negative tactical deviations correspond to an overweight/neutral/underweight stance for each respective asset class and market segment relative to their strategic allocation. The current allocation is the sum of the strategic asset allocation and the tactical deviation.Note that the regional allocations on the Equities and Bonds pages in UBS House View are provided on an unhedged basis (i.e., it is assumed that investors carry the underlying currency risk of such investments) unless otherwise stated. Thus, the deviations from the strategic asset allocation reflect the views of the underlying equity and bond markets in combination with the assessment of the associated currencies. The detailed asset allocation tables integrate the country preferences within each asset class with the asset class preferences in UBS House View.Asset allocation does not assure profits or prevent against losses from an investment portfolio or accounts in a declining market.
NOTE: TACTICAL TIME HORIZON IS APPROXIMATELY SIX MONTHS
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Disclaimer
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Research publications from Chief Investment Office Global Wealth Management, formerly known as CIO Americas, Wealth Management, are published by UBS Global Wealth Management, a Business Division of UBS AG or an affiliate thereof (collectively, UBS). In certain countries UBS AG is referred to as UBS SA. This publication is for your information only and is not intended as an offer, or a solicitation of an offer, to buy or sell any investment or other specific product. The analysis contained herein does not constitute a personal recommendation or take into account the particular investment objectives, investment strategies, financial situation and needs of any specific recipient. It is based on numerous assumptions. Different assumptions could result in materially different results. We recommend that you obtain financial and/or tax advice as to the implications (including tax) of investing in the manner described or in any of the products mentioned herein. Certain services and products are subject to legal restrictions and cannot be offered worldwide on an unrestricted basis and/or may not be eligible for sale to all investors. All information and opinions expressed in this document were obtained from sources believed to be reliable and in good faith, but no representation or warranty, express or implied, is made as to its accuracy or completeness (other than disclosures relating to UBS). All information and opinions as well as any prices indicated are current only as of the date of this report, and are subject to change without notice. Opinions expressed herein may differ or be contrary to those expressed by other business areas or divisions of UBS as a result of using different assumptions and/or criteria. At any time, investment decisions (including whether to buy, sell or hold securities) made by UBS and its employees may differ from or be contrary to the opinions expressed in UBS research publications. Some investments may not be readily realizable since the market in the securities is illiquid and therefore valuing the investment and identifying the risk to which you are exposed may be difficult to quantify. UBS relies on information barriers to control the flow of information contained in one or more areas within UBS, into other areas, units, divisions or affiliates of UBS. Futures and options trading is considered risky. Past performance of an investment is no guarantee for its future performance. Some investments may be subject to sudden and large falls in value and on realization you may receive back less than you invested or may be required to pay more. Changes in FX rates may have an adverse effect on the price, value or income of an investment. This report is for distribution only under such circumstances as may be permitted by applicable law.
Distributed to US persons by UBS Financial Services Inc. or UBS Securities LLC, subsidiaries of UBS AG. UBS Switzerland AG, UBS Deutschland AG, UBS Bank, S.A., UBS Brasil Administradora de Valores Mobiliarios Ltda, UBS Asesores Mexico, S.A. de C.V., UBS Securities Japan Co., Ltd, UBS Wealth Management Israel Ltd and UBS Menkul Degerler AS are affiliates of UBS AG. UBS Financial Services Incorporated of Puerto Rico is a subsidiary of UBS Financial Services Inc. UBS Financial Services Inc. accepts responsibility for the content of a report prepared by a non-US affiliate when it distributes reports to US persons. All transactions by a US person in the securities mentioned in this report should be effected through a US-registered broker dealer affiliated with UBS, and not through a non-US affiliate. The contents of this report have not been and will not be approved by any securities or investment authority in the United States or elsewhere. UBS Financial Services Inc. is not acting as a municipal advisor to any municipal entity or obligated person within the meaning of Section 15B of the Securities Exchange Act (the "Municipal Advisor Rule") and the opinions or views contained herein are not intended to be, and do not constitute, advice within the meaning of the Municipal Advisor Rule.
UBS specifically prohibits the redistribution or reproduction of this material in whole or in part without the prior written permission of UBS. UBS accepts no liability whatsoever for any redistribution of this document or its contents by third parties.
Version as per April 2018.
© UBS 2018. The key symbol and UBS are among the registered and unregistered trademarks of UBS. All rights reserved.
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Accounting and Financial Reporting Update: Insights and Trends
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With You Today
MIKE HOTTELNational Assurance Partner, Atlantic Regional Technical Partner
KATE BLUVOLDirector, Accounting & Transaction Services
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Accounting Update ASC 842 - Leases Revenue recognition – lessons
learned Financial Instruments - CECL
FASB Accounting Standards Updates
SEC Update Commission Activities
PCAOB Update Future of the PCAOB Auditor Reporting Model
Agenda
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Accounting Update
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ASC 842 - The New Lease Accounting Standard
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ASC 842Effective Dates
Public business entities FYs beginning after 12/15/18 (and interim periods within) Early adoption permittedNonpublic entities FYs beginning after 12/15/19 (interim periods within FYs beginning after
12/15/20) Early adoption permitted
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ASC 842Lessee Overview
Right of use model – recognize ROU asset and lease liability at inception for all leases• Optional exemption for leases with terms < 12 months
Classify all leases as finance or operating (5 criteria)• Finance lease – lessee effectively obtains control of underlying asset• Operating lease – lessee does not effectively obtain control of underlying
asset Similar balance sheet impact; different income statement and cash flow results
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ASC 842Lessor Overview
Classify all leases as sales-type, direct finance, or operating (similar to existing U.S. GAAP) based on same criteria as lessees, plus a few others• Sales-type lease - transfers all risks and rewards, plus control of underlying
asset, to lessee• Direct financing – transfers risks and rewards but not control• Operating – does not transfer risks and rewards or control
Subsequent accounting is consistent with existing U.S. GAAP* Control principle aligned with new revenue standard
* Leveraged lease treatment no longer available for new leases
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Identifying a Lease
LeaseA contract, or part of a contract, that conveys the right to control the use of identified property, plant, or equipment (an identified asset) for a period of
time in exchange for consideration
Determine at inception based upon: Whether contract fulfillment depends on use of an identified asset* Whether contract conveys right to control use of identified asset for
consideration for a time period
* Consider whether supplier has substantive right of substitution
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Identifying a Lease
Right to control use of the identified asset depends upon:• Right to obtain substantially all economic benefits from the use of the
identified asset (e.g., through using, holding, or subleasing the asset).― “Economic benefits” is fairly broad― Consider within defined scope of customer’s contractual right to use the
asset• Right to direct the use of an identified asset. This exists when customer has
the right to direct how and for what purpose the asset is used, including the right to change how and for what purpose the asset is used, throughout the period of use.
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Lease Classification
Five criteria for finance lease (lessee) / sales-type lease (lessor):1. Transfer of ownership of underlying asset to lessee by end of lease term2. Option to purchase underlying asset that lessee is reasonably certain to
exercise3. Lease term = major part of remaining economic life of underlying asset4. Sum of PV lease payments and PV any residual value guaranteed by lessee ≥
substantially all of the FV of underlying asset5. Underlying asset is of such a specialized nature that it is expected to have no
alternative use to lessor at end of lease term
If one or more of the above are met, classify as finance/sales-type lease.
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Lease Classification
When none of the first five criteria are met, two other criteria for direct financing classification should be evaluated (lessor):
1. PV of lease payments + residual value guarantee by third party equals or exceeds substantially all of underlying asset FV.
2. It is probable that lessor will collect lease payments plus residual value guarantee.
Both of the above criteria must be met for a lessor to classify as direct financing. Otherwise, classify as an operating lease.
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INITIALMEASUREMENT
Right-of-use asset
Present value (PV) of lease payments + lessee’s initial direct costs
Initial direct costs: Incremental costs directly attributable to negotiating and arranging a lease
Recognize lease incentives as a reduction in the right-of-use asset
Lease liability (LL)
PV of lease payments
Private company practical expedient - use risk-free rate to measure LL
SUBSEQUENTMEASUREMENT
Right-of-use asset
Amortized cost: Method of amortization depends on lease classification (finance or operating)
Impairment: Refer to existing standards (ASC 360)
Lease liability
Amortized cost: Use the effective interest method
Private company practical expedient - use risk-free rate to measure LL
Lessee Accounting
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Example: Lessee Accounting
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Example: Lessee Accounting
Facts: Lessee enters into a 10-year lease of an asset, with an option to extend for an
additional 5 years. Lease payments are $50,000 per year during the initial term and $55,000 per
year during the optional period, all payable at the beginning of each year. Lessee incurs initial direct costs of $15,000. At the commencement date, Lessee concludes that it is not reasonably certain
to exercise the option to extend the lease and, therefore, determines the lease term to be 10 years.
Lessee’s incremental borrowing rate is 5.87 percent. Present value of remaining lease payments after payment of 1st year rental is
$342,017
What is the initial accounting for the lease?
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Lessee – Initial Accounting
Journal entry to record assets & liabilities at commencement:
Right-of-use asset $ 407,017
Lease liability $ 342,017
Cash (lease payment for year 1) $ 50,000
Cash (initial direct costs) $ 15,000
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Finance Lease – Subsequent Accounting
Journal entry to recognize lease expense during 1st year, if finance:
1. Calculated as (5.87% × $342,017) 2. Calculated as ($407,017 ÷ 10 yrs)
Interest expense $ 20,076 1
Lease liability $ 20,076
Amortization expense $ 40,702 2
Right-of-use asset $ 40,702
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Finance Lease – Subsequent Accounting
Journal entry to recognize lease expense during 2nd year, if finance:
1. Calculated as [5.87% × ($342,017 + $20,076 – $50,000)] 2. Calculated as ($407,017 ÷ 10 yrs)
Lease liability $ 50,000
Cash $ 50,000
Interest expense $ 18,320 1
Lease liability $ 18,320
Amortization expense $ 40,702 2
Right-of-use asset $ 40,702
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Operating Lease – Subsequent Accounting
Journal entry to recognize lease expense during 1st year, if operating:
1. Calculated as [($500,000 + $15,000) ÷ 10 yrs]2. Calculated as (5.87% × $342,017) 3. Calculated as ($51,500 - $20,076)
Lease expense $ 51,500 1
Lease liability $ 20,076 2
Right-of-use asset $ 31,424 3
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Operating Lease – Subsequent Accounting
Journal entry to recognize lease expense during 2nd year, if operating:
1. Calculated as [($500,000 + $15,000) ÷ 10 years]2. Calculated as [5.87% × ($342,017 + $20,076 – $50,000)] 3. Calculated as ($51,500 - $18,320)
Lease liability $ 50,000
Cash $ 50,000
Lease expense $ 51,500 1
Lease liability $ 18,320 2
Right-of-use asset $ 33,180 3
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Lessee Accounting Example
Total lease expense recognized over life of lease – Finance vs. Operating(in $000s, approximate)
0
10
20
30
40
50
60
70
Year 1 Year 9
Finance
Operating
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Transition
Lessee & lessor transition Modified retrospective approach with hindsight allowed for evaluating renewal
and purchase options on existing leases. No option for full retrospective. New transition approach issued in ASU 2018-11: Initially apply Topic 842 at
adoption date Significant relief provisions allowed as a policy election – No reassessment of:
• Whether any expired or existing contracts are or contain leases• Classification for any expired or existing leases• Initial direct costs for expired or existing leases
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Transition
Lessee & lessor transition Leveraged lease treatment grandfathered (unless modified after adoption date) Sale-leaseback transition:
• No reassessment of prior successful sale/leaseback conclusions• Specific transition for deferred gains (or losses) related to sale and
capital/operating leaseback transactions Specific transition for build-to-suit arrangements
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Updated in 2018, BDO’s Leases Practice Aid provides broad resources and examples to assist lessees, lessors, and practitioners in complying with the leasing standard ASU 2016-02 issued by the Financial Accounting Standards Board in 2016, taking effect beginning 2019.https://www.bdo.com/insights/assurance/fasb/fasb-newsletter-october-2018
Leases – BDO Newsletter
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ASC 326 – Measurement of Credit Losses on Financial Instruments
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Current Expected Credit Losses (CECL) Overview
In June 2016, the FASB issued ASU 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments
Two distinct credit loss impairment models:• Subtopic 326-20: CECL impairment model for financial assets measured at
amortized cost (e.g. HTM debt securities and trade receivables)• Subtopic 326-30: AFS debt securities impairment model
Recognition of full “lifetime” expected credit losses upon initial recognition of an asset
Replacement of the current incurred loss impairment model that recognizes losses when a probable threshold is met
Expected credit losses estimate is based on historical information, current conditions and reasonable and supportable forecasts
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At a Glance: ASC 326-20 (CECL)
Accounting for Credit Losses
Existing Guidance New Guidance
Timing of Recognition As Incurred Immediately – Upon Origination or Acquisition
When Lifetime Credit Losses are Expected
Measurement Amount Specific Losses Incurred Total Credit Loss Expected over the Contractual Life of
an Instrument
Probability Threshold Probable~ > 80%
Possible
Primary Basis for Estimation Current Circumstances and Historical Experience
Reasonable, Supportable Forecasts
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At a Glance: ASC 326-30 (AFS Debt Securities)
Accounting for Credit Losses
Existing Guidance New Guidance
Account Presentation Direct Asset Write-down Allowance for Credit Losses
Measurement of Recognized Loss
Proceeds minus ACB (if sold); ACB less FV (if other than
temporary impairment OTTI)
Excess of ACB > PV of Discounted Cash Flows
(limited to the FV floor)*
Measurement of OCI amounts
Excess of ACB > FV (unless sold or OTTI)
Portion of FV decline unrelated to credit losses
Credit Loss Reversal No immediate reversal of previously recognized credit
losses
Permits the reversal of allowance in earnings to the extent that expected cash
flows improve
* If either 1) Entity intends to sell before ACB can be recovered; or 2) > 50% probability will be required to sell before ACB can be recovered – entire impairment is recognized in
earnings.
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Specific Considerations for Commercial Entities and Trade Receivables Significant impact on investments in HTM and AFS debt securities Credit losses for Topic 606 assets:
• Aging schedules method may be used to estimate credit losses under CECL• Historical credit loss experience should be adjusted for asset-specific risk
characteristics• Loss rates should be adjusted to reflect current economic conditions and
reasonable and supportable forecasts of future economic conditions • No credit loss recognition threshold and up-front loss recognition is required
Due to the short duration of contract assets and trade receivables, the effect of switching to a lifetime expected loss model may not be significant • Assessment should be performed at each reporting period
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ASC 606 – Revenue – Lessons Learned
66
ASC 606 Effective Dates
Public business entities Fiscal years beginning after 12/15/17 (and interim periods within) Early adoption permitted only as of FYs beginning after 12/15/16 (and interim
periods within)Nonpublic entities FYs beginning after 12/15/18 (and interim periods within FYs beginning after
12/15/19) Early adoption permitted as of either:
• FYs beginning after 12/15/16 (and interim periods within), or• FYs beginning after 12/15/16 and interim periods within FYs beginning one
year after the annual period in which an entity first applies the new standard.
Per ASU 2015-14, Deferral of the Effective Date
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Transition
ASC 606 is required to be applied retrospectively by one of the following methods:
1. Retrospective application to each reporting period presented in accordance with ASC 250-10-45-5 through 45-10 (i.e. full restatement of comparative figures).
2. Modified retrospective with one or more practical expedients (i.e., completed contracts, use of hindsight for variable consideration, etc.), through a cumulative effect of change at adoption date (disclose effect of applying new standard)
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ASC 606The Five Step Model
Core Principle:
Recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.
STEP 1:
Identify The Contract
STEP 2:
Identify Separate
Performance Obligations
STEP 3:
Determine Transaction
Price
STEP 4:
Allocate Transaction
Price to Performance Obligations
STEP 5:
Recognize Revenue When/As
Performance Obligations Satisfied
Steps to Apply the Core Principle Are:
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Top 3 Lessons Learned – ASC 606
Lesson 1 – Know Your Customer Contracts Topic 606 requires a fresh look at your contracts. Do you have them at hand? Are contractual terms standardized or non-standardized? Opportunities to consider changes to contracts for preferential accounting
treatment or standardize contracts Assessment of contract approvals (enforceable rights and obligations) and
modifications
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Top 3 Lessons Learned – ASC 606
Lesson 2 – New Key Concepts Impact by Industry Assessment of Performance Obligations, material rights? Variable Consideration Treatment of IP Licenses – Functional or Symbolic Costs to Obtain a Contract – now required to be capitalized if amortized over a
period of greater than one year. Disclosures are key!
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Top 3 Lessons Learned – ASC 606
Lesson 3 – Revenue Implementation is Bigger than a Breadbox
Universally takes more time than anticipated…get started The white paper is only the beginning Internal controls and impacts on systems There are resources out there (TRG, 10-K of adopters in your industry,
AICPA industry task forces What is the collateral impact? Impact on key metrics, compensation
arrangements, debt covenants?
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BDO Knows Newsletters Topic 606 – Presentation and Disclosure (October
2017)
Topic 606 – Exploring Transition Methods (October 2017)
Overview of Topic 606 (March 2017)
Self-Study Programs ASC 606, Revenue from Contracts with Customers
Applying the New Revenue Standard, Part 1
Applying the New Revenue Standard, Part 2
BDO Revenue Resource Center https://www.bdo.com/services/assurance/revenue-
recognition/overview
REVENUEBDO Resources
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FASB Updates
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FASB Priorities
Monitor and assist in implementation efforts for new standards• Revenue• Leases
Finalize the long-duration insurance contract and disclosure framework projects
Progress on conceptual framework
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Final ASUs Issued To Date in 2018
Information is current as of October 31, 2018
ASU 2018- Title BDO Alert
01 Leases (Topic 842): Land Easement Practical Expedient for Transition to Topic 842 Alert
02Income Statement—Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated OtherComprehensive Income
Alert
03Technical Corrections and Improvements to Financial Instruments—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities
Alert
04Investments—Debt Securities (Topic 320) and Regulated Operations (Topic 980): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 117 and SEC Release No. 33-9273 (SEC Update)
Alert
05 Income Taxes (Topic 740): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 118 (SEC Update) N/A
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Final ASUs Issued To Date in 2018
ASU 2018- Title BDO Alert
06 Codification Improvements to Topic 942, Financial Services—Depository and Lending N/A
07 Compensation—Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting Alert
08 Not-for-Profit Entities (Topic 958): Clarifying the Scope and the Accounting Guidance for Contributions Received and Contributions Made Alert
09 Codification Improvements N/A
10 Codification Improvements to Topic 842, Leases Alert
11 Leases (Topic 842): Targeted Improvements Alert
12 Financial Services—Insurance (Topic 944): Targeted Improvements to the Accounting for Long-Duration Contracts Alert
Information is current as of October 31, 2018
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Final ASUs Issued To Date in 2018
Information is current as of October 31, 2018
ASU 2018- Title BDO Alert
13 Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement Alert
14Compensation—Retirement Benefits—Defined Benefit Plans—General (Topic 715-20): Disclosure Framework—Changes to the Disclosure Requirements for Defined Benefit Plans
Alert
15Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract
Alert
16Derivatives and Hedging (Topic 815): Inclusion of the Secured Overnight Financing Rate (SOFR) Overnight Index Swap (OIS) Rate as a Benchmark Interest Rate for Hedge Accounting Purposes
Coming Soon
17 Consolidation (Topic 810):Targeted Improvements to Related Party Guidance for Variable Interest Entities Coming Soon
78
SEC Update
79
SEC Organizational Changes
Kara Stein
(Democrat)
EladRoisman
(Republican)
HesterPeirce
(Republican)
Walter Jay Clayton
(Independent)
Chair Commissioners
RobertJackson Jr.(Democrat)
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Select Commission Focus Areas
Capital Formation Disclosure Effectiveness Cybersecurity Topics of Broad Interest
• Staff study on interim reporting • SEC and staff revisiting thresholds that require audits of ICFR
81
PCAOB Update
82
PCAOB leadership
Board Members Board members are appointed by the SEC to staggered
five-year terms.
William D. Duhnke III Chairman
J. Robert Brown Jr.
Kathleen M. Hamm
Duane M. DesParte
James G. Kaiser
13
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PCAOB Transitions for the FutureChairman’s Perspectives
Under Chairman Duhnke, the PCAOB is performing broad outreach both internally and externally to help set its strategic plan for the next 5 years
The PCAOB is pursuing the need for a fresh look at operational and program designs as well as improvements to policy-making and external engagement
Inspections process and reporting along with PCAOB oversight programs are of significant interest
PCAOB promotion of continuous improvement in the quality of audit services through prevention, detection, and remediation of audit deficiencies
Recent resources for consideration:• Chairman’s May Transition Speech:• Chairman’s October Pursuit of Continuous Improvement in Audit Quality
Speech:• PCAOB Annual Report
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Recent Significant Standard Setting and DisclosurePCAOB AS 3101: Auditor Reporting Model
PCAOB Auditing Standard (AS) 3101 significantly changes the auditor’s report
*Critical Audit Matters (CAMs) will be voluntary disclosure for audits of broker dealers, investment companies other than business development companies, employee benefit plans, and emerging growth companies
New Auditor Reporting Provisions
Effective Date
Report format, tenure, and additional information
Audits for fiscal years ending on or after 12/15/2017
Communication of CAMs* for audits of large accelerated filers
Audits for fiscal years ending on or after 6/30/2019
Communication of CAMs* for audits of all other companies
Audits for fiscal years ending on or after 12/15/2020
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Disclosure of critical audit matters (CAMs) Report will include introductory
language regarding CAMs Additionally report will:
• Identify the CAM• Describe principal considerations
that led auditor to determine matter is a CAM
• Describe how the CAM was addressed in the audit
• Refer to relevant F/S accounts and disclosures related to the CAM.
PCAOB AS 3101What’s Changing for 2019/2020?
CAM
Involved especially
challenging, subjective or
complex auditor
judgment
Matter relating to accounts or
disclosures material to F/S
Matters communicated
or required to be communicated
to AC
NOTE: Large accelerated filers will adopt first – for audits for FY ending on or after 6/30/19; others 12/15/20
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Auditor and Audit Committee (AC) Communications CAM introduces incremental potential
meaningful information not previously provided to investors
Auditors are not expected to provide original information unless necessary to describe principle considerations (expected to be rare)
Opportunity to enhance discussions between AC, management and auditors
Opportunity to provide customized content unique to each company’s audit – NOT boilerplate!
Examples will continue to developMonitoring Both SEC* and PCAOB* have made it clear
that they will be closely monitoring the implementation and economic analysis of impacts and unintended consequences of the new standard
* Refer to SEC Chairman Clayton’s statementand PCAOB Staff guidance
PCAOB AS 3101What Does All This Mean?
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PCAOB AS 3101CAM Implementation and Reporting Timeline
Key: Phase 1 – Initial Report Changes effective for ALL filers: 12/15/2017Phase 2 - Critical Audit Matters (CAM) Reporting effective for:
• Large Accelerated Filers (LAF): 6/30/2019• All Other Filers: 12/15/2020
Today
2017 2018 2019 2020 2021
12/15/17Phase 1: Initial Report Changes
6/30/19 Phase 2: CAM Reporting
LAF CAM Implementation
All Other Filers CAM Pilot
LAF CAM Post-Implementation
All Other Filers CAM Implementation
6/30/18 LAF CAM Pilot
6/30/19
6/30/19
6/30/19
12/15/20
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PCAOB AS 3101Auditor Reporting Model & CAM Implementation
SEC Chief Accountant Bricker auditor/AC communication points relative to critical audit matters (CAMs): What would the CAMs be this year? What would be the close calls? When could those matters have been raised, and which
ones could have been identified at the start of the audit cycle?
What does the auditor expect to say about those matters?
When would we expect to see a draft report or at least a draft of the critical audit matters? https://www.thecaq.org/resources
Audit committees, management, auditors, and regulators will and should be paying attention to the results of large accelerated filer “dry runs”
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BDO Insights: The Future of Auditor Reporting is Here
Final PCAOB Rule: https://pcaobus.org/Rulemaking/Docket034/2017-001-auditors-report-final-rule.pdf
PCAOB Staff Guidance: https://pcaobus.org/Standards/Documents/2017-12-04-Auditors-Report-Staff-Guidance.pdf
CAQ Publications: • The Auditor’s Report: Considerations for
Audit Committees• Critical Audit Matters: Key Concepts and
FAQs for Audit Committees, Investors…
PCAOB AS 3101 Resources
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Data Protection & Privacy Overview: What Every CFO Needs to Know
Data Protection & Privacy Overview
What Every CFO Needs to Know
92 BDO YEAR-END PRESENTATION
93 BDO YEAR-END PRESENTATION
Topics
DATA PROTECTION & PRIVACY BUSINESS DRIVERS
WHY PRIVACY LAWS ARE CHANGING
NEW PRIVACY LAWS IMPACTING YOUR BUSINESS
PRIVACY PROGRAM CONSIDERATIONS
STEP 1. PROGRAM EVALUATION
STEP 2. BUILD THE PROGRAM
STEP 3. HOLISTIC CYBER RISK MANAGEMENT
STEP 4. CONSIDER THE CONSUMER
STEP 5. PRIVACY PROGRAM GOVERNANCE
VENDOR CONSIDERATIONS
Q & A
94 BDO YEAR-END PRESENTATION
DATA PROTECTION & PRIVACY BUSINESS DRIVERSWHY PRIVACY IS SUCH A HOT TOPIC
95 BDO YEAR-END PRESENTATION
WHY PRIVACY LAWS ARE CHANGINGTHE IMPACT OF THE CONSUMERS’ VOICE
73%...
…of consumers say a company’s ability to keep their data private is extremely
important.
…of consumers say businesses focus on profits over protecting consumers’
privacy rights.
At least 15 large retailers have experienced loss of personal data since January 2017.
78%...
Source: Harris Poll for IBM, online survey of 2,039 U.S. adults March 27-29
96 BDO YEAR-END PRESENTATION
NEW PRIVACY LAWS IMPACTING YOUR BUSINESSGENERAL DATA PROTECTION REGULATION
The General Data Protection Regulation (GDPR) imposes new rules on organizations that offer goods and services to people in the European Union (EU), or that collect and analyze data tied to EU residents, no matter where they are located. Effective May 25, 2018
Enhanced personal privacy rights
Increased duty for protecting data
Mandatory breach reporting
Significant penalties for non-compliance
Fines are up to 4% of global revenues or €20 million, whichever is greater.
97 BDO YEAR-END PRESENTATION
NEW PRIVACY LAWS IMPACTING YOUR BUSINESSCALIFORNIA CONSUMER PRIVACY ACT
The California Consumer Privacy Act will provide gives Californians the most sweeping, comprehensive and empowering consumer privacy rights in the country. Many of your clients will be subject to this law. Effective January 1, 2020
Right to know all data collect by a business about you
Right to say NO to the sale of your information
Right to Delete your data
Mandated opt-in before the sale of children’s information
Enforcement by the Attorney General of the State of California and Private Right of Action when there is a breach.
98 BDO YEAR-END PRESENTATION
OPERATIONS
PRINCIPLES
OBLIGATIONS
INDIVIDUAL RIGHTS
Policies, procedures, IT, security, third parties,
products
Personal data locations, notice, consent, data
transfers
Fair, lawful, data minimization, accuracy,
storage limitations
Access, restriction, erasure, transparency, objections,
portability, cookies
Satisfying GDPR and California Consumer Privacy Act requires current state assessments.
PRIMARY PROGRAM CONSIDERATIONSPRIVACY ASSESSMENTS
99 BDO YEAR-END PRESENTATION
STEP 1. PROGRAM EVALUATIONREMEDIATION & IMPLEMENTATION
PROCESSING ACTIVITIES REGISTER
DEVELOPMENT
DATAMINIMIZATION
TRAINING & AWARENESS
PRIVACY PROGRAM
DEVELOPMENT
POLICYDEVELOPMENT
Legal basis for processing, categories of data, retention periods,
transfers, safeguards
Only keep what is needed and is allowed
under the laws
Policies that align with the regulations,
business, legal and IT needsDevelop holistic
privacy governance programs that meet business and legal
needs
Develop awareness campaigns required
under the GDPR
100 BDO YEAR-END PRESENTATION
STEP 2. BUILD THE PROGRAMEND-TO-END SOLUTION CONSIDERATIONS
Data Mapping Compliance Strategies DPIAs Data Subject
Requests Accountability
Map local and global data stores to identify
personal data.
Assist the privacy governance committee
with long term strategies
Develop and perform assessments to evaluate the
soundness of processes and technologies
Manage and respond to
data subject requests
Respond to authorities,
oversee compliance,
retention schedules, data categorization
COMBINE SUBJECT MATTER EXPERTISE WITH MACHINE LEARNING, DATA SCIENCE AND
CLOUD COMPUTING TO MAKE IT EASIER TO MEET PRIVACY AND COMPLIANCE
CHALLENGES.
101 BDO YEAR-END PRESENTATION
STEP 3. HOLISTIC CYBER RISK MANAGEMENTA COMPONENT OF A STRONG DATA PRIVACY GOVERNANCE PROGRAM
Cybersecurity risk management is not just about technology.
A holistic approach:
Addresses how the cybersecurity strategy needs to align with the business strategy.
Recognizes that people and culture are important elements of the process.
Recognizes that the target industry is a driver of cyber threats.
Understands that managing risk has a cost and ROI.
102 BDO YEAR-END PRESENTATION
SecurityHow secure is my data?
NoticesWhat rights do I have with your company?
LocationWhere is my data located?
ChangesHow can I correct my personal data?
ChoicesDid your company receive consent to use
or share my data?
STEP 4. CONSIDER THE CONSUMERDATA SUBJECT REQUESTS AND WHAT THEY WANT TO KNOW
103 BDO YEAR-END PRESENTATION
STEP 5. PRIVACY PROGRAM GOVERNANCEIT’S NOT ENOUGH TO IMPLEMENT A SOLUTION
STRATEGY & VISION
PROGRAMDEVELOPMENT
ON-GOINGMANAGEMENT &
MONITORING
DATA PROTECTION OPERATIONALIZETHE PROGRAM
Define the program scope, align with the business, develop the
data governance strategy
Structure the teams, develop the privacy framework, policies
and procedures
Implement the privacy framework, define
metrics and audiences, assess the organization
and third partiesIntegrate privacy with SDLC, DPIAs,
implement technical controls
Audit compliance with privacy policies
and standards
104 BDO YEAR-END PRESENTATION
SystematicTrusted processes and
procedures
Market tested
Global responsivenessJust-in-time global services
and tools
Subject matter expertiseTrained and certified
professionals
PragmaticReasonable approaches
and value for fees
Reputable
Value for level of expertise
Proven methodologies
VENDOR CONSIDERATIONSWHAT TO LOOK FOR WHEN SELECTING A PARTNER
105 BDO YEAR-END PRESENTATION
Q&ACALL US IF YOUR CLIENT ASKS ABOUT…
PRIVACY
INFORMATION GOVERNANCE
DATA PROTECTION
GDPR ORCA CONSUMERPRIVACY ACT
RECORDSMANAGEMENT
106
Lunch Break
107
Latest Updates on Wayfair, Federal, SALT, and International Tax Issues
108
Key U.S. business tax changes
Reduction in Corporate and Individual Tax Rates
Repeal of Alternative Minimum Tax and the Domestic Production Activity Deduction (DPAD)
Change in Net Operating Loss (NOL) Lives and Limitation on Use
Increased Revenue Threshold to Qualify for the Cash Method of Accounting
Increases in Sec. 179 Expensing and Changes to Bonus Depreciation
Changes to the Deduction of Meals and Entertainment
30 % Business Interest Expense Limitation Rate Reduction for Pass-Through
Entities Under Sec. 199A
109
Key U.S. international tax changes
“Hybrid” Territorial Tax System (Participation Exemption)
Interest/Royalty Payments Involving Hybrid Transactions/Hybrid Entities
Global Low-Taxed Intangible Income (GILTI)
Toll-Charge on Mandatory Repatriation of Foreign Earnings
Foreign Derived Intangible Income (FDII)
Base Erosion and Anti-Abuse Tax (BEAT)
Foreign Persons Sales of Partnership Interests (PS has U.S. T/B)
Expansion of U.S. Shareholder Definition and CFC Anti-Deferral Rules/Modification of FTC rules
110
2018 State Tax Developments
111
Overview
State Reactions to Tax Reform
Application of Wayfair US Supreme Court Decision and Other Nexus Developments
Apportionment Developments
Tax Base
Unitary Combined Reporting & Filing Options
Related Party Transactions, Intercompany Debt & Economic Substance
Pass-Through Entities
DC/Maryland/Virginia Updates
State Enacted Economic Nexus Laws and Regulations
112
State enacted economic nexus laws and regulations
113
Wayfair Decision
On June 21, 2018, the U.S. Supreme Court issued its decision in South Dakota v. Wayfair, Inc..
In a 5-4 decision, the Court ruled in favor of South Dakota and overruled Quill Corp. v. North Dakota and National Bellas Hess, Inc. v. Department of Revenue of Ill.
The Court concluded that “the physical presence rule of Quill is unsound and incorrect.”
As a result, a physical presence is no longer required for substantial nexus under the (dormant) Commerce Clause for any state tax.
Please see www.bdo.com/Wayfair for latest state thresholds for sales and use tax purposes
114
www.bdo.com/wayfair
CA
OR
WA
NVUT
AZNM
CO
MT
WY
ID
ND
SD
KS
NE
OK
LATX
MO
AR
IA
MN
WI
IL IN
TN
KY
ALMS
FL
GA
MI
SC
NC
WVVA
PA
OH
NY
ME
NH
DE
RI
NJ
DC
HI
AK
Enacted statute/rule/admin
Enforcement suspended
Proposed in 2018
Statute/Rule not enacted to date*
*AK, DE, MT, NH, OR have no sales/use tax
States with Sales/Use Tax Economic Nexus Statutes(AS OF 10/8/2018)
VT
MD
CT
MA
115
Businesses Impacted
Retail and Consumer Products
• e-Commerce
• Service providers
Technology
• Online services (SaaS, sellers of digital products)
Private Equity/M&A
• PE firms and strategic buyers will need to address Wayfair exposure and ongoing compliance requirements of their portfolio companies and targets.
Non-U.S. Businesses
• U.S. tax treaties generally do not apply at the state level.
• A foreign business with no US permanent establishment may still be subject to state economic nexus provisions.
All industries are likely to see an impact from the Wayfairdecision, but these are likely the most widely impacted.
116
Apportionment and market-based sourcing for income taxes
117
CA
OR
WA
NVUT
AZNM
CO
MT
WY
ID
ND
SD
KS
NE
OK
LATX
MO
AR
IA
MN
WI
IL IN
TN
KY
ALMS
FL
GA
MI
SC
NC
WV*VA
PA
OH
NY
ME
NH
DE
RI
DC
HI
AK
MBS Required
MBS Required (2019)
MBS Elective
States Requiring Market-based Sourcing
NJ
VT
MD
MA
CT
118
Market-Based Sourcing – Current Status
Market-Based Sourcing
Where Benefit Received
Market-Based Sourcing
Where Service Received
Market-Based Sourcing
Where Service Delivered
Market-Based Sourcing
Where Customer Located
Arizona (election) Connecticut Alabama Georgia
California Illinois Colorado (2019) Maryland
Iowa Maine District of Columbia Nebraska
Michigan Minnesota Kentucky Oklahoma
Missouri (election)* Louisiana
New Jersey (years ending on/after 7/1/2019)
Massachusetts
New York Montana
New York City Oregon
Rhode Island Pennsylvania
Utah Tennessee
Wisconsin
*Missouri will require MBS starting 2020
119
State conformity to the TCJA corporate tax base-broadening provisions
120
State Conformity to Base-Broadening Provisions
Principle Federal Changes with State Impact Amended IRC Section 163(j) changes business interest expense limitation.
Amended IRC Section 172 imposes NOL limitations and makes other changes.
Amended IRC Section 243 reduces DRD for dividends received from non-affiliates.
Amended IRC Section 118 changes gross income treatment of state and local contributions to capital of corporations.
Repeal of IRC Section 199 domestic production activities deduction (most states already decoupled).
121
Emerging Trends in the M&A Landscape
122
Breakout 1 – Session 1
Tax Reform Impacts on Flow-Through Business Owners and Other Personal Tax Changes
123
Tackle Tax Reform: Section 199A
Joan Holtz and Meredith Pilaro
124
Agenda – Sec. 199A Deduction Computations
Assessment of Company Situation
Computational Considerations
Sample Company Situations and Results
Questions and Answers
125
The Section 199A DeductionAssessment of Company SituationKey Steps: 1. Identify each trade or business2. Determine whether trades or businesses are Qualified Trades or
Businesses (QTBs) or Specified Services Trades or Businesses (SSTBs)3. Evaluate data to identify QBI, W-2 wages and UBIA of qualified
property4. Evaluate per-owner data
126
The Section 199A DeductionAssessment of Company Situation
Qualified Trade or Business
A “qualified trade or business” means any trade or business other than a specified services trade or business (“SSTB”) or the trade or business of performing services as an employee.
In order to apply these rules, the following two-step approach should be taken:
1. Determine whether the taxpayer operates one or more trades or businesses. Note that if the taxpayer does not operate a trade or business no portion of its taxable income will be eligible for the QBI Deduction.
2. With respect to each identified trade or business, evaluate whether the trade or business involves an SSTB or the performance of services as an employee.
127
The Section 199A DeductionAssessment of Company Situation
Qualified Trade or Business – Section 162 Trade or Business
In general, a trade or business means a Section 162 trade or business other than the trade or business of performing services as an employee.
Rental or licensing of tangible or intangible property (rental activity) that does not rise to the level of a Section 162 trade or business is nevertheless treated as a trade or business for purposes of Section 199A, if the property is rented or licensed to a trade or business which is commonly controlled.
o The activities will be considered commonly controlled if the same person or group of persons, directly or indirectly, owns 50 percent or more of each trade or business to be aggregated.
Determination of a trade or business under Section 162 based on facts & circumstances
128
The Section 199A DeductionAssessment of Company Situation
Qualified Trade or Business – Specified Service Trade or Business
A specified service trade or business means any trade or business involving the performance of services in one or more of the following fields: (i) health, (ii) law, (iii) accounting, (iv) actuarial sciences, (v) performing arts, (vi) consulting, (vii) athletics, (viii) financial services, (ix) brokerage services, (x) investing and investment management, (xi) trading, (xii) dealing in securities, partnership interests, or commodities, and (xiii) any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees or owners.
Special rules:
• De minimis rule based on gross receipts
• Property or services provided to a related SSTB
• Incidental to an SSTB
129
Section 199A –Computational Considerations
130
The Section 199A DeductionComputational Considerations – Owner Level
Computational Rules – Taxable income not in excess of threshold amountIn general, the QBI Deduction is equal to the lesser of the following amounts:
1. The sum of: - 20 percent of the total QBI amount (including QBI attributable to an SSTB) plus
- 20 percent of the combined amount of qualified REIT dividends and qualified PTP income (including the individual's share of qualified REIT dividends, and qualified PTP income from relevant passthrough entities (“RPEs”)).
2. 20 percent of the amount by which the individual's taxable income exceeds net capital gain.
W-2 wages & UBIA of qualified property limitations do not apply
Status of a trade or business as an SSTB does not impact the QBI Deduction
131
The Section 199A DeductionComputational Considerations – Owner Level
Computational Rules – Taxable income in excess of threshold amountIn general, the QBI Deduction is equal to the lesser of the following amounts:
1. The sum of: - The QBI component plus
- 20 percent of the combined amount of qualified REIT dividends and qualified PTP income including the individual's share of qualified REIT dividends, and qualified PTP income from RPEs.
2. 20 percent of the amount by which the individual's taxable income exceeds net capital gain.
W-2 wages & UBIA of qualified property limitations apply
Status of a trade or business as an SSTB needs to be considered
132
The Section 199A DeductionComputational Considerations – Owner Level
Computational Rules – Taxable income in excess of threshold amountThe QBI component is calculated using the following computational rules, which are to be applied in the order they appear:
1. SSTB exclusion
2. Aggregated trade or business
3. Netting
4. Carryover of negative total QBI amount
5. W-2 wages & qualified property limitation
W-2 wages & UBIA of qualified property limitations apply
Status of a trade or business as an SSTB needs to be considered
133
The Section 199A DeductionComputational Considerations – Owner Level Section 199A Owner-level Aggregation Rules – Requirements
Trades or businesses may be aggregated only if:
1. There is common ownership;
2. The ownership exists for a majority of the taxable year;
3. All of the items to be aggregated are reported in the same taxable year;
4. None of the trades or businesses to be aggregated is an SSTB; and
5. The trades or businesses satisfy at least two of the following factors:
A. Provide products and services that are the same or customarily offered together.
B. The trades or businesses share facilities or share significant centralized business elements.
C. The trades or businesses are operated in coordination with, or reliance upon, one or more of the businesses in the aggregated group
Unless aggregated, the Wage and Capital Limitations apply to each trade or business.1. (for example, supply chain interdependencies).
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The Section 199A DeductionComputational Considerations – Owner Level
Determination & Allocation of QBI – Treatment of Specific Items QBI includes gains treated as ordinary income under section 751(a) (from the sale or exchange of a
partnership interest) or section 751(b) (from a partnership distribution) to the extent that the other requirements of section 199A are met.
Guaranteed payments for the use of capital under section 707(c) are not QBI, but the partnership’s deduction of such payments may constitute QBI if the other requirements of section 199A are met.
Section 481(a) adjustments (relating to accounting method changes) attributable to a trade or business may be QBI, provided that the method change was made for a taxable year that ends after December 31, 2017.
Losses that are suspended from taxable years ending after December 31, 2017 are generally QBI in the year in which they are deducted. Typical suspended losses include the following:
• Section 465 at-risk losses;
• Section 469 passive activity losses;
• Section 704(d) basis limitations for partnership interests; and
• Section 1366(d) basis limitations for S corporations.
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The Section 199A DeductionComputational Considerations – Owner Level
Determination & Allocation of QBI – Net Operating Losses and QBI
A net operating loss deductible under section 172 is not taken into account in determining QBI because net negative QBI is accounted for separately under section 199A(c)(2).
Section 461(l) imposes a new limitation of $250,000 ($500,000 for MFJ) on the annual deduction of net business losses of non-corporate taxpayers. Any amount in excess of this limitation is carried forward to the next taxable year as a net operating loss under section 172.
Because a loss disallowed under section 461(l) is not deductible in the year sustained, it is not allowable in determining QBI for that year. Thus, to the extent that a taxpayer’s net operating loss includes amounts carried forward under section 461(l), the loss is included in QBI, to the extent the other requirements of section 199A are met.
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The Section 199A DeductionComputational Considerations – Owner Level
Determination & Allocation of QBI – Items Not Specifically Addressed
The above-the-line deduction for one-half of an individual’s self-employment tax liability
Qualified retirement contributions
Unreimbursed partner business expenses
Allocation of section 1231 losses if some of the losses for a taxable year are QBI while others do not relate to a trade or business
Self-employed health insurance deduction
Unrecaptured 1250 gains
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The Section 199A DeductionComputational Considerations – Owner Level
W-2 Wages and UBIA Limitation
The 20% deduction for QBI from each trade or business is limited to the greater of:
• 50% of the W-2 Wages paid with respect to the trade or business generating the QBI or
• 25% of the W-2 Wages paid with respect to the trade or business generating the QBI plus 2.5% of the unadjusted basis immediately after acquisition (UBIA) of qualified property attributable to the trade or business generating the QBI
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The Section 199A DeductionComputational Considerations – Entity Level
W-2 Wages – Determination of W-2 Wages
There is a three-step process for determining the wages paid with respect to a trade or business that are properly allocable to QBI:
1. Each individual or RPE must determine its total W-2 wages paid for the taxable year
2. Each individual or RPE must allocate its W-2 wages among its trades or businesses (if there is more than one)
3. Each individual or RPE must determine the amount of wages under #2 above that are allocable to the QBI of the trade or business
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The Section 199A DeductionComputational Considerations – Entity Level
W-2 Wages – Determination of W-2 Wages
Notice 2018-64 – Proposed revenue procedure provides three methods for calculating total W-2 wages:
1. Unmodified Box Method – Lesser of: Total box 1 wages for all employees or Total box 5 wages for all employees
2. Modified Box 1 Method – Box 1 wages for all employees are adjusted by the following amounts:
• Subtract amounts included in box 1 that are not wages for Federal income tax withholding purposes (i.e. supplemental unemployment compensation benefits)
• Add amounts reported in box 12 that are properly coded D, E, F, G and S
3. Tracking Wages Method – Total amount of wages subject to Federal income tax withholding plus amounts reported in box 12 that are properly coded as D, E, F, G and S
Method #1 is the least burdensome but methods #2 and #3 are more accurate
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The Section 199A DeductionComputational Considerations – Entity Level
W-2 Wages – Determination of W-2 Wages
W-2 Wages are total wages under section 3401(a), elective deferrals under section 402(g)(3), compensation deferred under section 457, and any Roth contributions under section 402A
In order for any wages to count they must be included on forms filed with the Social Security Administration (SSA)
Wages must be paid to employees of the taxpayer for employment by the taxpayer
Special rules will also apply when a trade or business is acquired or disposed of during the year and when there is a short taxable year
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The Section 199A DeductionComputational Considerations – Entity Level
W-2 Wages – Allocation of W-2 Wages to Trade or Business
The individual or RPE must allocate wages among their multiple trades or businesses using a reasonable method based on all facts and circumstances
• The method must be consistently applied from one taxable year to the next
• The method must clearly reflect income and expenses for each trade or business
• While the same method used for wages doesn’t have to be used for allocating other items between trades or businesses, the overall combination of methods must also be reasonable based on all facts and circumstances
• The books and records maintained for a trade or business must be consistent with the method used for these allocations
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The Section 199A DeductionComputational Considerations – Entity Level
W-2 Wages – Allocation of W-2 Wages to QBI
Once wages have been allocated to a trade or business they can be allocated to QBI to the extent the wage expense is taken into account in calculating the QBI for that trade or business
For RPEs the wage expense must then be reported to each owner for each trade or business:
• For partnerships each partner’s share of W-2 wages is based on their allocable share of wage expenses
• For S corporations each shareholder’s share of W-2 wages is based on their pro rata share of wage expenses
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The Section 199A DeductionComputational Considerations – Entity Level
UBIA of Qualified Property – Definition of Qualified Property
The term qualified property means, with respect to any trade or business of an individual or RPE for a taxable year, tangible property of a character subject to the allowance for depreciation under Section 167(a):
• Which is held by, and available for use in, the trade or business at the close of the taxable year,
• Which is used at any point during the taxable year in the trade or business's production of QBI, and
• The depreciable period for which has not ended before the close of the individual's or RPE's taxable year.
Property acquired within 60 days of year end must be used in the trade or business for 45 days within a 120 day period after acquisition
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The Section 199A DeductionComputational Considerations –Entity Level
UBIA of Qualified Property – Definition of UBIA
UBIA is the basis of property as of the placed in service date of the property.
UBIA is determined without regard to any adjustments described in Section 1016(a)(2) or (3), to any adjustments for tax credits claimed by the individual or RPE (for example, under Section 50(c)), or to any adjustments for any portion of the basis for which the individual or RPE has elected to treat as an expense (for example, under Sections 179, 179B, or 179C).
However, UBIA does reflect the reduction in basis for the percentage of the individual's or RPE's use of property for the taxable year other than in the trade or business.
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The Section 199A DeductionComputational Considerations – Entity Level
UBIA of Qualified Property – Definition of Depreciable Period
The term depreciable period means, with respect to qualified property of a trade or business,
• The period beginning on the date the property was first placed in service by the individual or RPE and
• Ending on the later of
A. The date that is 10 years after such date, or
B. The last day of the last full year in the applicable recovery period that would apply to the property under Section 168(c), regardless of any application of Section 168(g).
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The Section 199A DeductionComputational Considerations – Entity LevelUBIA of Qualified Property – Allocation to Owners
The UBIA is allocated to partners and shareholders of RPEs as follows:
• For qualified property currently generating tax depreciationo The partner or shareholder’s share of UBIA is the same proportion as their share of tax
depreciation bears to the entity’s total tax depreciation for that property
• For qualified property not currently generating tax depreciation:o For partners their share of UBIA is based on how gain would be allocated to them pursuant
to sections 704(b) and 704(c) if the qualified property were sold for cash equal to its fair market value
o For shareholders their share of UBIA is based on the ratio of shares held by them in the S corporation to total shares of the S corporation
Implications:
• Due to bonus depreciation and section 179 UBIA is likely to include significant amounts of fully depreciated property
• Proper capital account maintenance will be critical to properly allocating UBIA for partnerships
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Section 199A –Sample Company Situations and Results
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Example 1
F, an unmarried individual, owns as a sole proprietor 100% of 3 trades or businesses, Business X, Business Y and Business Z.
Business X generates $1m of QBI and pays $500k of W-2 wagesBusiness Y generates $1m of QBI and pays $0 of W-2 wagesBusiness Z generates $2,000 of QBI and pays $500k of W-2 wagesNone of the businesses hold qualified property
F’s taxable income including income from other sources and allowable deduction unrelated to the businesses above is $2,722,000
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Example 1- no aggregation
Step 1: Because QBI from each business is positive, F applies the limitation by determining the lesser of 20% of QBI and 50% of W-2 wages for each business:Business X: 20% QBI = ($1m x 20%) $200k, 50% W-2 = ($500k x 50%) $250kBusiness Y: 20% QBI = ($1m x 20%) $200k, 50% W-2 = ($0 x 50%) $0Business Z: 20% QBI = ($2,000 x 20%) $400, 50% W-2 = ($500k x 50%) $250k
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Example 1- no aggregation
Step 2: F must combine the amounts determined in Step 1 and compare that sum to 20% of F’s taxable income. The lesser of these 2 amounts determines F’s QBI deduction:Step 1 total: $200k + $0 + $400 = $200,40020% F taxable income: $2,722,000 x 20% = $544,400Total QBI deduction: $200,400
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Example 1- with aggregation
Step 1: F combines the QBI and W-2 amounts to compute the QBI component:Business X, Y, Z: 20% QBI = (($1m + $1m + $2k ) x 20%) $400,400Business X, Y, Z: 50% W-2 = (($500k +$0 + $500k) x 50%) $500k
Step 2: F must combine the amounts determined in Step 1 and compare that sum to 20% of F’s taxable income. The lesser of these 2 amounts determines F’s QBI deduction:Step 1 total: $400,40020% F taxable income: $2,722,000 x 20% = $544,400Total QBI deduction: $400,400
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Example 2
F, an unmarried individual, owns as a sole proprietor 100% of 3 trades or businesses, Business X, Business Y and Business Z.
Business X generates $1m of QBI and pays $500k of W-2 wagesBusiness Y generates $1m of QBI and pays $0 of W-2 wagesBusiness Z generates $600k of negative QBI and pays $500k of W-2 wagesNone of the businesses hold qualified property
F’s taxable income including income from other sources and allowable deduction unrelated to the businesses above is $2,120,000
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Example 2- with a loss but no aggregation
Step 1: Because Business Z had negative QBI, F must offset the positive QBI from Business X and Business Y with the negative from Business Z in proportion to the relative amounts of positive QBI from Business X and Business Y. Because Businesses X and Y produced the same amount of positive QBI the negative QB is apportioned equally.
Using Adjusted QBI:Business X: 20% QBI = ($700k x 20%) $140k, 50% W-2 = ($500k x 50%) $250kBusiness Y: 20% QBI = ($700k x 20%) $140k, 50% W-2 = ($0 x 50%) $0Business Z: 20% QBI = ($0 x 20%) $0, 50% W-2 = ($500k x 50%) $250k
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Example 2- with a loss but no aggregation
Step 2: F must combine the amounts determined in Step 1 and compare that sum to 20% of F’s taxable income. The lesser of these 2 amounts determines F’s QBI deduction:Step 1 total: $140k + $0 + $0 = $140,00020% F taxable income: $2,120,000 x 20% = $424,000Total QBI deduction: $140,000
There is no carryover of any loss into the following taxable year for purposes of section 199A.
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Example 2- with a loss and aggregation
Step 1: F combines the QBI and W-2 amounts to compute the QBI component:Business X, Y, Z: 20% QBI = (($1m + $1m - $600k ) x 20%) $280,000Business X, Y, Z: 50% W-2 = (($500k +$0 + $500k) x 50%) $500k
Step 2: F must combine the amounts determined in Step 1 and compare that sum to 20% of F’s taxable income. The lesser of these 2 amounts determines F’s QBI deduction:Step 1 total: $280,00020% F taxable income: $2,120,000 x 20% = $424,000Total QBI deduction: $280,000
There is no carryover of any loss into the following year for purposes of section 199A.
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Example 3 – a loss carrying forward (no aggregation)
Assume the same facts as Example 1 except Business Z generates a loss that results in $2,150,000 of negative QBI and pays $500k of W-2 wages with respect to the business in 2018. Thus, F has negative combined QBI of $150k when all businesses are added together.
F has no QBI deduction with respect to any trade or business for 2018. The negative $150k carries forward and will be treated as negative QBI from a separate trade or business for purposes of computing the QBI deduction in 2019. None of the W-2 wages carry forward.
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Example 3- carryforward negative QBI
In 2019, F’s businesses have the following results:
Business X generates $200k of QBI and pays $100k of W-2 wagesBusiness Y generates $150k of QBI and pays $0 of W-2 wagesBusiness Z generates $120k of negative QBI and pays $500 of W-2 wagesCarryforward negative QBI of $150kNone of the businesses hold qualified property
F’s taxable income including income from other sources and allowable deduction unrelated to the businesses above is $960,000
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Example 3- carryforward negative QBI
Step 1: Because Business Z had negative QBI and there is carryforward negative QBI, F must offset the positive QBI from Business X and Business Y with the negative from Business Z and the carryforward in proportion to the relative amounts of positive QBI from Business X and Business Y. Because Business X produced 57.14% of the total QBI from Business X and Business Y, 57.14% of the negative QBI must be apportioned to X and the remainder to YCalculation of Adjusted QBI for 2019:
Description Business X Business Y Business Z
QBI 200,000 150,000 (120,000)
% of QBI 57.14% 42.86%
Neg. QBI (68,568) (51,432)
Carryover (85,710) (64,290)
Adjusted QBI 45,722 34,278 0
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Example 3- carryforward negative QBI
Calculation of 20% Limitation and W-2 Limitation:
Business X: 20% QBI = ($45,722 x 20%) $9,144, 50% W-2 = ($100k x 50%) $50kBusiness Y: 20% QBI = ($34,278 x 20%) $6,856, 50% W-2 = ($0 x 50%) $0Business Z: 20% QBI = ($0 x 20%) $0, 50% W-2 = ($500 x 50%) $250
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Example 3- carryforward negative QBI
Step 2: F must combine the amounts determined in Step 1 and compare that sum to 20% of F’s taxable income. The lesser of these 2 amounts determines F’s QBI deduction:Step 1 total: $9,144 + $0 + $0 = $9,14420% F taxable income: $960,000 x 20% = $192,000Total QBI deduction: $9,144
There is no carryover of any loss into the following taxable year for purposes of section 199A.
If F aggregated in this scenario, the total QBI deduction would have been $16k.
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Example 4 – Multiple Trades or Business, with SSTB
Description Totals TB#1 – SSTB TB#2 – QTB TB#3 - QTB
Gross Revenue $5,700,000 $1,500,000 $2,000,000 $2,200,000
Direct Labor 1,000,000 400,000 500,000 100,000
G&A Labor 1,200,000 200,000 700,000 300,000
Other Costs 1,500,000 200,000 600,000 700,000
Net Revenue 2,000,000 700,000 200,000 1,100,000
QBI considerations –
QTB#1 and QTB#2 may or may not qualify for aggregation at owner level
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Example 4 – Owner’s Calculation
Assume Ownership Percentage of 33%
QBI QTB#1 = $66,000 QTB#2 = $363,000
W-2 wages $396,000 $132,000
50% Limitation $198,000 $66,000
20% of QBI $13,200 $72,600
Assume 20% of Taxable income (reduced by capital gain) exceeds $72,600
Assume Owner’s income over threshold for SSTB limitation to not apply.
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Example 5 – Impact of entity structure on W-2 wage limitation
Description Total LLC S-Corporation
Service Revenue $78,125
Product Revenue 2,500,000
Direct Labor 500,000
Owner Labor 200,000
Other Costs 350,000
Results
QBI $1,528,125 $1,528,125
W-2 Wages 500,000 700,000
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Example 5 – Owner’s Calculation
Assume Ownership Percentage of 33%
QBI $504,281
Assume 20% of Taxable income (reduced by capital gain) exceeds $100,856Assume Owner’s income over threshold for limitation to not apply.
W-2 wages $165,000 $231,000
50% Limitation $82,500 $115,500
20% of QBI $100,856 $100,856
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Questions?
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Breakout 1 – Session 2
Government Contracting: A Year in Review and the Landscape Ahead
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With You Today
KIM CLARK PAKSTYSManaging Director
ERIN O’SHEADirector
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Agenda
FY 2019 National Defense Authorization Act (NDAA) Bid Protest Updates GSA/Commercial Items Updates Trends in Mergers & Acquisitions SCA/DBA Contracting Updates 2019 Outlook
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Fiscal Year 2019 National Defense Authorization Act (NDAA)
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FY19 NDAAOverview
Department of Defense (DoD) Bid Protest Studies and Reforms
Other Transactions Agreements (OTA)
Lowest Price Technically Acceptable (LPTA) Source Selection
Increasing Competition at the Task Order (TO) Level
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FY19 NDAADepartment of Defense (DoD) Bid Protest Studies and Reforms
Past NDAAs have alleged potential issues with the bid protest process:• Timeline• Cause delays in the acquisition process• Impact the Agencies’ abilities to acquire what they need• Incumbent protests to increase their own contract time/value
FY17 NDAA resulted in the RAND Study. The study issued in December 2017 concluded that bid protests do not have a significant effect on the DoD’s procurement process
FY19 NDAA mandates for a new study and report to be conducted in relation to “second bite” protests filed at both CoFC and GAO
FY19 NDAA also requires a plan and schedule developed by Dec. 1, 2019 to expedite the DoD protest process for awards valued at $100k or below
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FY19 NDAAOther Transaction Agreements (OTAs)
Benefits of using an OTA• An OTA is not a contract, grant, or cooperative agreement
− Not subject to many procurement laws or regulations. FAR does not apply.
• Intended to allows for a streamlined process of procuring research and prototype projects
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FY19 NDAAOther Transaction Agreements (OTAs)
NDAA history regarding OTAs• Congress codified the DoD’s authority to use funded OTAs in FY16 NDAA for
prototype projects• FY18 NDAA took issue with the overly restrictive interpretation of using OTAs
− Lack of education and awareness of OTAs led to unnecessarily restrictive contracting methods for programs that could have otherwise been funded through OTAs.
• FY19 NDAA addressed concern on the lack of transparency in OTA awards − Congress has mandated that the DoD provide an annual report on the OTA
process. − First report is due to Congress no later than 12/31/18. Reports to follow
annually until 2021.
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LPTA procurements have frequently been under scrutiny • Zero incentive to contractors to
provide enhanced technical solutions
• LPTA has been misused to procure services that require technical innovation and superiority
• LPTA protests typically result in the Agency’s favor if the awarding methodology is clearly identified
In the FY19 NDAA, Congress has prohibited the use of LPTA procedures effective December 2018 for:• IT• Telecommunications Services• Personal Protective Equipment
operations• Systems Engineering• Other knowledge-based
professional• Logistic services for contingency
FY19 NDAALowest Price Technically Acceptable (LPTA) Source Selection
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LPTA will be permitted only when the following criteria have been met:• Minimum requirements are clear,
measurable, and articulated• Agency is subject to no, or low,
liability from a contract proposal not surpassing the minimum requirements
• It can be established that the review of technical proposals would not or could not provide greater value to the selection process
• Source selection must be completely free from subjective judgement
• Agency’s CO has justified the use of LPTA method and full lifecycle costs have been considered during award
FY19 NDAALowest Price Technically Acceptable (LPTA) Source Selection
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FY19 NDAAIncreasing Competition at the Task Order (TO) Level
Solicitations are all currently required by law to include a cost or price as an evaluation factor that must be considered
This presents a problem when evaluating the price/cost element of IDIQ proposals when task orders may not have been fully developed
FY19 NDAA §876 creates exceptions for services acquired on an hourly-rate basis under IDIQ multiple-award contracts and federal supply schedule contracts.• Agencies have the discretion to not include cost/price as an evaluation
factor• If cost/price is not considered as an evaluation factor, the cost/price must
be considered at the time of task or delivery order award under a contract that resulted from the specific solicitation.
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Bid Protest Updates
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RAND Report
The RAND Report was an independent study on bid protests required by the FY17 NDAA. The results of the study were issued to Congress on Dec. 21, 2017.
The study considered:• The nature and value of the contracts that are protested• The total share of DoD contract values protested• The outcome of the protests• The effect of debriefings on the protests filed• The frequency of corrective action elected by the Agency when the
protestor is successful
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RAND Report
The study found:• Protests are unique• While the number of contracts protested has increased substantially, the
total value of contracts protested has remained small - less than 0.3%• Effectiveness rates at GAO have remained relatively steady suggesting that
meritless protests are not filed as often as suggested• Task order protests have a higher effectiveness rate than other types of
protests; small business protests are more frequent and less successful• Agencies and the private sector view protests differently
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RAND Report
The study concluded that:• Enhancing the quality of post-award debriefings may limit the number of
meritless protests• A reduction in the timeline for bid protest resolution may not be required• Restricting task order protests may not be necessary or recommended• A consideration of an expedited process for the protest of contracts valued
at $100k may be necessary to ensure that the cost of seeing the protest through may exceed the value of the contract
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RAND Report
• Additional data points should be collected going forward to improve future studies: − Agency level protests− Acquisition Value− Second-bite protests− Corrective Action/Withdraw− CoFC timeline (1st decision, close, appeal)
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Enhanced Debriefings
FY18 NDAA required all DoD procurements to have enhanced post-award debriefings
Enhanced debriefings must provide:• Redacted Source Selection Award Determination
− For all procurements valued at greater than $100m− Option to release to small businesses for awards between $10-$100m
• Written or oral debriefings for all awards (including TO/DO awards >$10m)
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Enhanced Debriefings
• Following the initial debriefing, contractors have 2 business days to submit additional questions. − Agencies have 5 business days from receipt to respond− Debriefing is not considered closed until responses to the questions have
been submitted• 5-day clock starts the day the written responses are delivered
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GSA/Commercial Items Updates
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Order-Level Materials
In June, 2018 seven GSA schedules were updated to include OLM authority• Schedules: 03FAC, 56, 70, 71, 84, 00CORP, and 738X• GSA will consider adding OLM authority to additional schedules in the future
In order to be eligible for OLM, contractors must accept the OLM mass modification in order to provide OLMs on Scheduling orders • Contractor must accept the Commercial Supplier Agreement mass
modification before they can accept the OLM• The OLM SIN will be added to the contract automatically upon mass
modification acceptance• Acceptance of the mass modification is not mandatory. However, if it is
declined, the contractor may not have the opportunity to accept until the eMod system updates are complete (Jan 19?)
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Order-Level Materials
OLMs can only be procured under T&M orders or a T&M CLIN on a hybrid order OLMs must be less than 33.33% of the total dollar value (not items count) of the
order. • “Total Value” is the anticipated or recorded dollar value of the schedule
contract items at the time of order award, inclusive of option periods and IFF.
• Travel costs and open market items are excluded from “total value”• The 33.33% cap needs to be maintained throughout the order period
including the value of options and modifications.
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Order-Level Materials
• BPAs: The 33.33% limit applies to each individual BPA order, not across all orders under the BPA.
• Ordering Contracting Officer is responsible for monitoring compliance with the 33.33% limitation
• OLMs can be handled as open market items instead of OLMs to prevent exceeding the limit as long as the open market items comply with all applicable acquisition regulations.
If an OLM exceeds the Simplified Acquisition Threshold, the contractor must obtain 3 quotes to support the CO in its fair and reasonable price determination.
Contractors can recover indirect costs on their OLMs, but they must be proposed in fixed amounts.
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eBuy Transparency
“eBuy Open GSA First” pilot project launched by GSA to improve transparency and increasing competition via eBuy (only RFQ system)
Goal is to have more vendors participate in the federal marketplace by publically releasing post-award eBuy RFQ information on GSA procurements on FedBizOpps• Publishing post-award RFQ information publically will give contractors
greater insight and hopefully encourage additional vendors to pursue opportunities
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eBuy Transparency
One-year pilot will collect and analyze data from a test group and a control group.• Test group includes COs from the GSA Office of Internal Acquisition and FAS
Region 7 Southwest Supply and Acquisition Center for GSA funded procurements
• Control group are buyers who use eBuy but are not participating in the pilot to compare how results vary
Industry is concerned that transparency could lead to fewer quality bids and more protests. The pilot program aims to evaluate this concern, among others, and to see if the transparency leads to any unintended consequences.
Pilot is scheduled through 10/9/19
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TDR DevelopmentsOIG Audit Findings
GSA OIG Report was issued on July 26, 2018. TDR pilot program objectives are not well-defined. Overly broad pilot objectives include: Changes in prices, sales volume, small
business participation No indication how success of the above objectives will be measured or defined
• TDR launched in August 2016, but the evaluation plan was not established until March 2017
Some metrics lack performance targets. GSA cannot determine whether the TDR data is complete, accurate, and
reliability due to the unavailability of the data
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TDR DevelopmentsOIG Audit Findings
TDR Pilot metrics that lacked performance targets: Category manager usage, changes in contract-level pricing, changes in order-level pricing, oversight effectiveness, paperwork reduction act burden, small business utilization rate, and stakeholder data access
A majority of the metrics reply on data that is not available for use in or evaluation of the pilot. TDR data is restricted until GSA develops a plan to fully protect the data FAS officials cannot verify or validate if the data is complete, accurate, and
reliable Data unavailable to key stakeholders such as Contracting Officers
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Trends in Mergers & Acquisitions
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M&A TrendsThe Landscape
Seller Exit Plan Buyer Targets
Seller Preparation
Buyer Due Diligence &
Integration
Harmonization & Value Creation
Capabilities / Services / ProductsCustomersLocationContracts
Talent/ Clearances
InfrastructureRate / Cost StructureCulture & Leadership
ContractsCompliance
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M&A ConsiderationsDiligence Issues
GSA Schedule/Most Favored Customer • Transactional Data Reporting(TDR) have yet to resolve all GSA schedule
issues• Understanding the target’s policies, procedures, compliance mechanisms,
and reporting Employee Mapping
• Evaluating the target’s HR processes and policies, service contracts, and subcontractor agreements
• Does subcontractor staffing meet the prime contract requirements? Small Business Challenges
• Target’s status under SAM, teaming agreement, and subcontracts• Is the target compliant with SBA affiliation rules?• Does the target subcontract most of its work?
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M&A ConsiderationsDiligence Issues
Intellectual Property (IP) Issues• Does the target track and document IP developed with private money?• What framework does the target utilize to document IP development and
the source of funding? • Is any recordkeeping system in place?
Mitigation Strategies • Taking action before closing• Full disclosure from target before closing• Disclosing all the target’s liabilities, such as warranties, covenants, and/or
representations
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Corporate Governance & Decision Making• What is required to harmonize
structure and internal controls across organizations?
Systems & Processes • How will you bring the new
employees onto the existing systems?
Culture• Have you identified differences
between buyer and seller’s culture?
Employee Turnover & Retention• Who is responsible for identifying
and successfully assimilating employees?
Rate Structures & Margin• What steps are being taken to
rationalize, harmonize rate and cost structures to realize desired value and margin?
Compliance & Regulatory Exposure• Who is responsible for assessing
risk then aligning and integrating mitigation practices?
M&A ConsiderationsIntegration Issues
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SCA/DBA Contracting Updates
198
SCA/DBA ContractingCurrent Enforcement Environment
Previous Administration (2008 - 2016)• Heightened focus on Labor Law Compliance• DOL increased its enforcement army and placed contractor compliance with
labor laws under greater scrutiny • Increased number of audits and more in-depth audits• More severe consequences for violators
Current Administration (2017 – Present)• Limited leadership in place• Largely operating under status quo enforcement levels• Some increase in compliance agreements?
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SCA/DBA ContractingCurrent Enforcement Environment
Recent Developments• WHD held overtime rule listening session on October 17th, 2018 in
Washington, DC to propose a new salary threshold for paying overtime to white-collar workers next March
• On October 9th, 2018, DOL extends PAID Program for six months to allow employers to conduct audit, and self-report potential overtime and minimum wage violations
• DOL issued AAM No. 227 to increase the prevailing health and welfare fringe benefits hourly rate to $4.48 / $4.18
• Starting January 1st, 2018, DOL is issuing opinion letters again
200
SCA/DBA ContractingCurrent Enforcement Environment
• New rules coming; Michele King became Acting Branch Chief in Government Contracts Enforcement through January 2019
• The federal contractor minimum wage increased to $10.35 on January 1, 2018; will be $10.60 in 2019
• Paid Sick Leave rule became effective January 1, 2017 with dual H&W rates effective last summer
201
SCA/DBA ContractingCurrent Enforcement Environment
FY 2018 SCA/DBA Audit Statistics
202
SCA/DBA ContractingTotal Cases
Includes SCA, DBA, and Contract Work Hours and Safety Standards (“CWHSSA”) Act Cases
0
500
1,000
1,500
2,000
2,500
3,000
3,500
2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
All Acts - Total Cases
Total Cases Cases with ViolationsLinear (Total Cases) Linear (Cases with Violations )
203
SCA/DBA ContractingSCA/DBRA Violations (FY09 to FY18)
0
5,000
10,000
15,000
20,000
25,000
30,000
35,000
2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
SCA/DBRA Total Violations
DBRA Cases with Violations SCA Cases with Violations
Linear (DBRA Cases with Violations) Linear (SCA Cases with Violations)
204
SCA/DBA ContractingSCA/DBRA Back Wages (FY09 to FY18)
0
5,000,000
10,000,000
15,000,000
20,000,000
25,000,000
30,000,000
35,000,000
40,000,000
45,000,000
2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
SCA/DBRA Back Wages
DBRA Back Wages SCA Back Wages
Linear (DBRA Back Wages) Linear (SCA Back Wages)
205
SCA/DBA ContractingSCA/DBRA Employees Receiving Back Wages (FY09 to FY18)
0
5,000
10,000
15,000
20,000
25,000
2009 2010 2011 2012 2013 2014 2015 2016 2017 2018
SCA/DBRA Number of Employees Receiving Back Wages
DBRA Employees Receiving Back Wages SCA Employees Receiving Back Wages
Linear (DBRA Employees Receiving Back Wages) Linear (SCA Employees Receiving Back Wages)
206
2019 Outlook
207
Top Trends in Government Contracting
Increased optimism and opportunity – Increased funding, driving consistency and stability in the market with new opportunities for national defense products and services.
Large, complex acquisitions for C4ISR and battle readiness capabilities – Drive additional M&A, partnership and contracting relationships.
New and Innovative Contracting Mechanisms –Simplified Acquisitions and Other Transactional Authority (OTA) encouraging nontraditional defense contractors to develop innovative technologies.
Sources: Washington Business Journal, Washington Technology, Federal Budget, GovCon Summit
208
Top Trends in Government Contracting
Continued GovCon Consolidations – M&A activity continues in the GovCon sector over the next 12-18 months – seeking new markets, economies of scale and reduced overhead.
Further Elimination of Duplicate and Outdated Regulations – Changes regulatory landscape for government contractors and introduces opportunity for commercial models for doing business.
Opportunities for Small Business – Continued focus on participation of small and economically diverse companies including the overhaul of the HUBZONE program.
209
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