In 2022, the significant changes to Section 174 went into effect. Enacted in 1954 as part of the Internal Revenue Code (IRC), Section 174 was created to eliminate uncertainty in tax accounting treatment of research and experimental development (R&E, or more popularly, R&D) expenditures and to simply encourage research and developmental experimentation as to way to grow innovation.

Section 174 allows businesses to either deduct or amortize certain R&D costs. Deductions can be made in the year in which they are paid or incurred, or they can be amortized over a period of not less than 60 months, beginning with the month in which the taxpayer first realizes benefits from the expenditures. Below are five things to know now about the updates to Section 174.

1. Which entities are subjected to Section 174 capitalization?

In short, Section 174 applies to any taxpaying entity that incurs qualifying R&D costs independent of specific industry or business size. Specifically, there are several types of businesses that are impacted, including:

• • • Corporations — Regardless of size, once corporations have incurred qualifying research and development costs;
    • Small businesses including startups — Regardless of current profitability status, small businesses and startups that are heavily invested in R&D may capitalize or amortize their research expenses;
    • Sole proprietorships, partnerships, and LLCs — Also, these entities can take advantage of Section 174 if they have qualifying R&D expenses; and
    • Past-through entities including S-corporations — These too can utilize Section 174 for eligible cost associated with R&D, and the R&D credits can be passed through partners, individual shareholders, or members.

2. What qualifies? What are the kinds of costs subject to Section 174 capitalization?

There are several categories of expenses that can be subject to Section 174 capitalization, including:

• • • Salaries and wages — The salaries and wages of employees who conducting or directly supervising or supporting research activities can be capitalized;
    • Supplies and materials — The cost associated with supplies used in the research process can be capitalized, including anything from lab equipment to the software required for the research;
    • Patent costs — The cost associated with obtaining patents for a product or process developed through research activities can be capitalized;
    • Overhead expenses — There are certain indirect expenses that can be allocated to research activities, including utilities for a research lab or depreciation on research equipment; and
    • Contract research expenses — If a third party is used to conduct the research on a company’s behalf, the cost can be capitalized.

3. What kinds of items are excluded from Section 174 deductions?

Not all R&D expenses can be deducted under Section 174. For example, costs for land or depreciable properties are not deductible. Additionally, costs associated with research conducted after the beginning of commercial production, marketing research, quality control, and funded research (such as research funded by any grant, contract, or otherwise by another person or governmental entity) are generally excluded.

4. What is considered R&D as defined by Section 174?

For tax purposes, the following four-part test from the Internal Revenue Service must be met in order to qualify for R&D credit:

• • • Business purpose — The research must be intended to benefit a business component, which can be any product, process, computer software, technique, formula, or invention that is to be held for sale, lease, license, or use by the company in a trade or business of the company.
    • Technological in nature — The business component’s development must be based on a hard science, such as engineering, physics, chemistry, the life or biological sciences, engineering, or computer sciences.
    • Elimination of uncertainty — The activity must be intended to discover information that would eliminate uncertainty about the development or improve of a product or process.
    • Process of experimentation — The business must evaluate multiple design alternatives or have employed a systematic trial-and-error approach to overcome the technological uncertainty.

5. Which states have conformity to Section 174?

Companies will have to check with the individual state in which they are filling in to determine if that particular state has conformed. States either conform to the IRC Section on a rolling basis or a static basic. A state that conforms on a rolling basis means it will automatically adopt any changes to the federal tax code as those changes occur. Some states that conform on a rolling basis include Illinois, New Jersey, New York, and Pennsylvania.

States that conform on a static basis adopt the federal tax code as of a specific date and do not automatically incorporate subsequent changes. Some static states include Florida, Georgia, Virginia, and North Carolina. There are some states that have selective conformity (this means they adopt selective portions of the IRC), including Arkansas, Colorado, and Oregon.

It is worthwhile to note that levels of conformity can vary by state and may be subject to specific adjustments, additions, or exceptions based on the individual state’s tax laws.

And these activities don’t include the time they need to spend on-boarding new clients, which can involve everything from gathering and analyzing years of financial statements to accommodating log-ins for each clients’ myriad banking and accounting systems.

Not surprisingly, this service model in the tax & accounting industry isn’t well suited for assessing cost-efficiency, especially since many accounting firms are moving to fixed monthly pricing. Accountants and bookkeepers are far too busy jumping among multiple tasks to record how much time they spend on specific activities, making it more difficult for firms to accurately track their costs. In addition, this way of working also leads to more rapid burnout among these professionals.

To solve this context-switching malaise, tax & accounting firms should consider switching to a service model that’s commonly used in many other industries: specialization. In many high-tech firms, for example, developers are no longer jacks-of-all-trades; instead, they’re assigned to specific tasks. Some code all day, some build prototypes, some are quality assurance specialists, and others focus solely on deployment. And coordinating all these activities is a project manager, who is responsible for implementing workflows and making sure that all tasks are completed accurately and on time.

And it’s not just software development companies that are using this model. Many larger tax & accounting firms have adopted this approach, and it’s one that smaller firms may want to consider as well.

Moving from generalists to specialists

For example, I work with a small accounting firm with a six-member CAS team, each of whom had to deal with the daily grind of doing everything for five assigned retail clients. Frustrations from this level of context-switching led to burnout and drove dissatisfaction that caused attrition among team members.

To solve this problem, the partners reorganized the CAS team into specialized groups. Each team now handles a specific set of accounting tasks for all 30 clients, including updating their assigned areas of each client’s general ledger. Here is how they assigned specific tasks to the CAS team:

• • • two members were assigned to an accounts receivable team and performed all A/R-related tasks;
    • two members handled A/P only;
    • one member handled clients’ payroll, working with each firm’s HR manager; and
    • the most senior experienced member served as controller and account manager, including the task of on-boarding new clients.

Since the firm implemented this specialization model more than a year ago, productivity and efficiency have significantly increased. Also, context-switching fatigue is no longer an issue, and specialists complete more tasks in less time. Job satisfaction has risen, and attrition has ceased. And with the firm expecting to add more than a dozen new clients every year, they’re actively looking to add additional headcount.

Implementing a specialization model in your firm

Depending on the size of your firm and the types of everyday activities conducted most often for clients you might want to consider other ways of moving to a specialized service model. For example, one person may be solely responsible for reconciling sales and booking revenue properly. Another might process invoices and bills, while another pays them. A junior member might start by doing nothing but analyze bank feeds, matching outgoing payments and incoming deposits to make sure everything balances. And a tech-savvy member might become the in-house on-boarding expert.

This last point on technical ability is important because a critical element of any successful transition from generalists to specialists is the quality of the accounting tools they have at their disposal. Right now, for example, your CAS team may be using their clients’ A/R, A/P, and payroll systems, which may not be the same ones your firm has chosen for in-house use. This places a significant burden on your accountants and bookkeepers, since they have to learn new systems every time a new client is brought on board. However, many accounting firms are choosing their own cloud-based accounting tools and requiring all new clients to migrate their information and records to these in-house systems.

As an added benefit, many of these accounting tools employ automation to streamline as many routine tasks as possible. For example, A/R-focused software can automatically download, analyze, enter, and reconcile sales transactions from most leading e-commerce and digital payment systems used by retailers and restaurants.

On the A/P side, automated accounts payable platforms can instantly capture and record each client’s paper and digital invoices and bills, categorize expenditures, approve funding requests and schedule one-time or recurring payments from one or more bank accounts.

And most online payroll platforms allow employees to enter their own regular, overtime, holiday, and vacation hours and then make automated payments to their bank accounts, accurately adjusted for taxes, healthcare insurance premiums, retirement contributions, and other pre-tax and after-tax deductions. These systems also track information needed for year-end tax reporting.

The best accounting automation tools can turbo-charge productivity among your accountants and bookkeepers, resulting in reduced stress and greater job satisfaction.

Making a successful transition

Whichever reorganization strategy your firm may choose, the key to implementing it successfully is convincing your generalists that becoming specialists is in their best interests.

There may be resistance at first, because even though they’re overworked, many of them take pride in owning the entire client relationship. Or, they may have concerns about having to double their client load.

Look for ways to emphasize the benefits of transitioning to a new specialist model. Consider bringing all of your accounting tools in-house, selecting systems that make it easier and faster for your team members to complete their assigned tasks for a larger number of clients. And sweeten the pot by letting them choose their preferred specialty area and the clients with whom they want to work.

Over time, offer your team members the opportunity to switch specialties and clients so they can deepen their expertise. If your firm is on a path toward adding headcount, offer a career track for those who want to become controllers.

Most of all, both during and after the transition, make sure you provide the support, resources, and incentives that your team members will need to flourish in their new roles.

Through taxes, governments can finance public initiatives and subsidize private investment in green industries and other initiatives, incentivizing a shift in private capital towards activities that will further the transition to net zero emission goals. Such investments will help prevent us from breaching our planetary boundaries and mitigate physical risks such as extreme weather, droughts, floods, and wildfires.

Tax credit investments

Investment tax credits at the federal level incentivize business investment. They let businesses deduct a certain percentage of investment costs from their taxes. In the context of green energy, tax credit investments return financial capital to companies to deploy directly into investments such as renewable energy, which boosts the investor’s ESG credentials and helps align the business with a low-carbon economy. Tax credit investments, which is a method used by corporations to provide funding for a project in exchange for the right to claim the available tax credit, enable corporations to use their access to capital to pursue their own path towards a sustainable economy in accordance with their risk/return assessments.

An increasingly popular option as part of an organization’s ESG strategy, tax credit investment has been and is set to become even more popular with the ambitious climate and energy policies of the Inflation Reduction Act (IRA), most of which relate to its more than 24 available tax credits. The IRA, which imposes a 15% corporate minimum tax, will drive $380 billion of investment into renewable energy and sustainable technologies, opening up new areas for tax credit investments such as electric vehicle charging infrastructure, bio-gas, green hydrogen, battery storage, and nuclear energy.

One significant change the IRA made to the clean energy tax credits is to make them refundable and transferable. Transferable tax credits allow companies to sell their tax credits to other entities for cash Refundable credits allow cash payment for tax credits if the amount owed is below zero.

Many U.S. companies need RECs in order to make progress towards their publicly stated goals, such as the country’s commitment to be net zero by 2050.

The Financial Accounting Standards Board, however, is now developing new guidance to clarify and smooth the process, and the Internal Revenue Service will be publishing guidance on the transferability of investment tax credits by mid-2023. Under the new rules, corporations can offset up to 75% of their federal income tax liability and roll this back three years, effectively gaining a rebate of taxes already paid to reinvest in ESG-positive opportunities.

Finally, renewable energy credits (RECs) are “tradeable, market-based instruments that represent the legal property rights to the ‘renewableness’ — or all non-power attributes — of renewable electricity generation,” according to the US Environmental Protection Agency (EPA). In effect, RECs assign ownership for the renewable aspects of the energy creation to the owner, allowing consumers to offset some of their carbon footprint.

Many U.S. companies need RECs in order to make progress towards their publicly stated goals, such as the country’s commitment to be net zero by 2050. Such credits provide a market and revenue stream for renewable energy-producing organizations. These opportunities enable companies to align themselves with a sustainable, green, low-carbon economy, which in turn, will likely lower companies’ transition and liability risks and their cost of capital.

There are also upsides as investors, lenders, and consumers recognize companies’ ESG-credentials. These opportunities for ESG-aligned investment will have notable social impacts around investments in infrastructure, human capital, and research & development. Job creation is a key outcome of investment in renewable energy, contributing to a just transition away from fossil fuels.

Under the IRA, a two-tiered system for renewable energy investment tax credits provides a base credit equal to 20% of the maximum credit and a bonus credit equal to an additional 80% of the maximum credit, but only if certain prevailing wage and apprenticeship requirements are satisfied in connection with the relevant project.

In addition, there are three adder credits that can be stacked on top of underlying credits for: i) meeting specific, domestic content requirements; ii) placing projects in the IRA’s defined energy communities; or iii) undertaking certain low-income solar activities.

While bringing more manufacturing jobs to the U.S. will strengthen employment overall, specifically selecting rural communities for large solar investments, for example, will provide an economic boom to those areas and enrich them through tax equity. There are further social benefits to community solar investments, which will have the ability to sell more than 50% of electricity generated to low-income families at discounted rates.

On the horizon

ESG alignment is the future of corporate investment, and companies should take advantage of the numerous investment opportunities that are emerging in the green transition.

In order to understand how companies can improve their status as social and environmental citizens and mitigate ESG-related risks, accurate measuring and reporting is needed as the first step. And tax credit investments are a direct, straight-forward way to turn this knowledge into a business upside.

In a time of economic and stock market uncertainty, tax credit investments offer a clear opportunity to grow and strengthen a company’s business strategy, while aligning it with the green transition.

This article was written for the Thomson Reuters Institute blog site by Foss & Co. For more information, contact ir@fossandco.com.

To find out how corporate tax leaders view these myriad challenges, KPMG surveyed 300 Chief Tax Officers (CTOs) from large U.S. companies with revenue of $2 billion or more and published the findings in its fourth annual 2023 Chief Tax Officer Outlook report.

The talent shift

Last year, CTOs surveyed rated talent as the top threat to organizational growth from a tax perspective, particularly reporting struggles with identifying and hiring talent with both tax and technology skills. This year, however, talent was rated last in a list of 10 risk factors that companies are facing over the next three years.

These results reflect both the turbulence of the times we live in and the degree to which tax leaders have absorbed the lessons of the pandemic and are re-thinking their priorities going forward, says Greg Engel, Vice Chair -Tax at KPMG. “Last year, talent was a big concern, but most of the people leaving the profession have cycled out, and we’ve adapted to a ‘new normal,'” Engel explains. “The question to focus on now is, how do we develop and train our people, and provide them with a satisfying career path?”

Tax managers have also learned how to fill skills gaps through outsourcing, Engel says. Indeed, 83% of the report’s respondents say they plan to use outsourcing, co-sourcing, or managed services within the next three years. The viability of a hybrid workforce also eases the talent burden, adds Engel, because it provides employees with greater flexibility.

A new threat to growth: ESG

While environmental, social, and governance (ESG) issues were at the bottom of the list of corporate risks last year, this year ESG concerns were ranked the number one threat to organizational growth over the next few years, ahead of regulatory changes, geopolitical fallout, supply-chain management, and global economic uncertainty.

The rise of ESG as a perceived threat to growth is a direct result of the extra reporting and responsibility that ESG initiatives require from corporate tax departments, Engel says. Everyone from the boardroom on down wants to be viewed as a “good corporate citizen,” he notes, and progress on ESG initiatives has become an important benchmark of responsible corporate behavior.

“As momentum has moved business forward on ESG, tax has a role in all of it, so it’s become a large reporting effort,” Engel explains. “On the G side, with reporting mandates on the horizon, we’ll begin to see more companies start to pay more attention to transparency and consider investing in tools or third-party providers that can help them tell their total tax story.”

The S and E sides heap extra responsibilities on tax departments as well, especially when it comes to navigating new environmental taxes and accessing government funding opportunities for ESG initiatives. If tax is a game of sticks and carrots, Engel says, tax departments are tasked with minimizing the sticks of ESG (e.g., new taxes on plastics or carbon), maximizing the carrots (e.g., tax incentives, grants, energy credits), and shaping the narrative about how the company is meeting its commitment to sustainable tax behavior.

According to KPMG’s report, attitudes about the tax department’s proper role have shifted so dramatically that a majority of CTOs (56%) now say it is more important to “be seen as a good corporate citizen” than it is to minimize the company’s tax burden. Transparency too has become such a hot-button topic that almost half (49%) of the companies surveyed said they are fully transparent and share significantly more tax detail than required.

Regulations & geopolitical factors

Changes in tax laws and regulations represent the number two threat to corporate growth cited in KPMG’s report. At both the domestic and international level, planned tax reforms and increased scrutiny from tax authorities promise to complicate compliance and add to the burden tax departments already feel, the report observes.

Meanwhile, 60% of CTOs expect that changing U.S. regulations will increase corporate taxation over the next two years. Almost as many (58%) also say new legislation included in the Inflation Reduction Act (IRA), including a minimum tax on corporations, will have a significant impact on their tax and compliance costs.

Unpredictability is the biggest headache, Engel says. “Companies and CTOs like consistency and predictability, and they don’t have any right now,” he says. “This is why as politicians debate tax policy changes, it’s critically important that companies model and plan for various scenarios.”

Furthermore, uncertainties about how operations and supply chains will be impacted by global inflation, trade tensions between the U.S. and China, and the ongoing Russian war in Ukraine are also top concerns for CTOs, especially those who work for large multinationals.

According to the report, CTOs say helping their companies understand the tax implications of international events — such as supply-chain disruptions, regional disputes, trade restrictions, currency controls, etc. — is becoming an increasingly important part of their job. “As supply-chain issues spur organizations to diversify from historically low-cost countries like China and India, CTOs are helping set up tax-efficient structures where the business wants to be,” the report states. “This includes helping supply-chain functions evaluate tax costs and risks associated with new supplier sourcing and potential operational moves.”

A seat at the table

Though many of these risk factors cited in the report add to the work burden and responsibilities that corporate tax departments must shoulder, Engel says they also offer tax leaders an opportunity to demonstrate the strategic and operational value of the tax function to the overall enterprise.

“Successful CTOs might already have a seat at the table, but it’s up to the CTO to bring strategic thinking to the table and that while it may have been harder to find tax at the top of the agenda in the past, it is less difficult to make that case today,” Engel adds.

“From ESG and regulatory changes to supply chain and geopolitical issues, and everything else in between — there is so much going on now that you really do have to have a strategic tax voice at the table,” he says. “CTOs just need to be prepared when they get the call.”

For some firms, it is part of their growth strategy, but for others it is a way revamp and reinvent their businesses. Not surprisingly, growth remained a top priority for most tax firms, according to the recently released 2023 State of the Tax Professional Report. Yet regardless of the reason, many tax & accounting firm leaders are wondering how best to move that strategy forward. And, for those firms that have yet to move forward because they were unsure how to make it happen, they have to think about how they will begin.

What is “scalability” for tax & accounting firms?

Nearly all tax & accounting firms need to look at how they can become scalable, says Mo Arbas, Senior Business Advisory Consultant for Tax & Accounting Professional Services at Thomson Reuters. Scalability is simply “an organization’s ability to grow without being hampered by its structure or available resources when faced with increased production.” In short — “increase revenue faster than cost,” explains Arbas, adding that for accounting firms it is merely about growth because for them, growth equals adding resources at the same rate as adding revenue.

Indeed, the difference between professional services firms and a business in which a physical product is produced and sold, is that the business understands and can more easily scale up the production of the product in order to have more products to sell, and therefore potentially increase sales and profits. Conversely, for professional services firms — and especially for small and solo tax firms — their product is, for example, the number of tax returns that can completed by the number of individuals who are required to get those done.

When a firm then looks to add services or even increase the number of tax returns it’s going to do, it will also have to look at what resources are needed to accomplish the desired increase.

Considerations before scaling

Interestingly, only 22% of new businesses launched in the past 10 years have successfully scaled their operations, according to a McKinsey & Co. There are many reasons why this number so low, but for professional services firms to have a better chance at success, there are a few factors that need to be considered, such as:

Setting goals — When setting goals to grow the business it is important to create a two-pronged approach and consider both the long-term and short-term goals. For the short-term growth goals, it is necessary to use a laser-like focus to make sure plans and executions are not too aggressive, too quickly which could be disastrous. If for example, the goal is to increase revenue by a certain dollar amount, first look at where that growth may come from among current clients or with current operations. Is it necessary to add new or additional services at this point?

Planning and trying to anticipate the most minute considerations that are required to launch and create additional services can be difficult. And not honestly and properly assessing where the company is currently can lead to significant consequences.

Evaluating resources — Author John Steinbeck said “…to find where you are going, you must know where you are.” And while Steinbeck was not speaking to tax firm leaders, this wisdom can be an important takeaway when they think about growing their tax & accounting businesses. To make sure that they scale in the right way, firms must assess what they currently have in terms of staff and technology.

For staff, taking an in-depth look at what each person does and how they contribute to the business is critical. Reviewing if those employees are being maximized in their current role and exploring whether their work can be automated or outsourced to free them up for new projects and opportunities can be an important benefit. Next, it would be crucial to evaluate if employees currently possess (or can be trained in) the skills needed to make those new business offerings possible.

Finally, leaders should do the same with all of their businesses’ technologies, including determining how these technologies are being used and if they are being maximized to their greatest potential. From here, they could then determine what, if any, new technology would be needed in order to scale up their businesses.

Identifying efficiencies — Leaders should also review current work process in order to understand what parts of the business operations are efficient and where improvements many need to be enacted. For leaders, this will be one of the cornerstones of successfully being able to scale their business. The more that can be done more efficiently through the work processes already in place within the business, the better position that business will be in to take on or create opportunities for growth.

For tax and accounting firm leaders who are focused on growth, their first consideration should be determining what type of service they want to deliver and to whom do they want to deliver it?

In order to help identify the services that would be the best fit, tax & accounting firm leaders can first look at “what services can be added that don’t require a lot of resources to deliver,” Arbas says, adding that leaders should remember that scalability within professional services equals product delivered with the time put in. “Firm leaders should view any opportunity through the lens of what benefits their firms and also their clients.”

Accounting firms are beginning to adapt to the new environment, but the sector is still enduring a period of transition. While deadlines for implementation do not come until 2025, instances of poor audit behavior continue to be seen in 2023.

In Australia, for example, the former head of international tax at PwC was banned for having made unauthorized disclosures to colleagues and clients about a government review committee on which he was serving. In the United Kingdom, PwC is being sued by former client Quindell for leaking confidential information during deal negotiations. In Germany, meanwhile, the audit regulator closed its investigation into EY’s handling of the Wirecard audit.

The transitional period in which the audit sector finds itself places tax & accounting firms in a more vulnerable position and raises the risks for organizations which engage with them, not least because accounting firms are increasingly becoming involved in advising organizations on the preparation and audit of their environmental, social and governance (ESG) data.

ESG developments

Regulatory focus on ESG has intensified over the past few years. At the international level, the Task Force on Climate-Related Financial Disclosures has provided final recommendations for consistent, comparable, reliable, clear, and efficient climate-related financial disclosures; and the International Sustainability Standards Board has consulted on exposure drafts of standards that deliver a comprehensive baseline for high-quality sustainability disclosure.

In the European Union, the Sustainable Finance Disclosure Regulation (SFDR) sets out a detailed disclosure regime that requires disclosures to be made at both the organizational and product level, meaning businesses need to have a detailed understanding of the composition of their products and services. In the U.K., new disclosure rules for companies with a U.K. premium listing are already in force, and the U.K.’s version of the SFDR is due to come into force this year.

While still in its early days, reports from the European Banking Authority and a joint report from the U.K.’s Financial Conduct Authority (FCA) and Financial Reporting Council (FRC) have revealed mixed levels of readiness for full disclosure. The European Central Bank reported that “banks do not yet sufficiently incorporate climate risk into their stress-testing frameworks and internal models, despite some progress made since 2020”, while the FCA and FRC reported that improvements still needed to be made in climate-related reporting.

Use of accounting firms

This web of regulations on ESG disclosure has led many organizations to realize that they lack the kind of detailed data needed to make the relevant reports which has prompted them to investigate ways in which such data could be extracted and reported. Given the need to find appropriate, available expertise on a tight deadline, it has seemed a natural route for many organizations to turn to their tax & accounting firms which already prepare their accounts for support and guidance. Accounting firms can undoubtedly help organizations with their preparations for ESG disclosures because they have up-to-the-minute knowledge of regulations and guidance.

Repeating mistakes

Accounting firms must, however, be careful to avoid repeating past mistakes when preparing for ESG compliance. Audit reforms were prompted by number of concerns, including the need to address the inherent conflicts between undertaking an audit of a company’s accounts while also petitioning for potentially more lucrative consulting work. One concern over this apparent conflict of interest is that it might make auditors reluctant to challenge management assumptions with sufficient rigor.

The FRC’s quality reviews also uncovered more widespread failure on the part of auditors to challenge management adequately. There was also concern that the accounting rules themselves are too detailed, encouraging accounting firms to take a tick-box approach. To that end, the FRC issued a Statement of Intent on ESG to provide guidance for the accounting profession when dealing with ESG data. First issued in 2021, the Statement “identified underlying issues with the production, audit, and assurance, distribution, consumption, supervision, and regulation of ESG information.” The FRC has recently issued an update outlining the areas in ESG reporting where challenges still remain.

Compliance’s role

Compliance officers have an invaluable role to play when their organization is considering the appointment of an auditor to prepare or audit its ESG data. As a first step, they would be well-advised to review their organization’s regulatory risk registers to ensure that the engagement of a particular accounting firm will not expose the organization to risk. Such risk exposure could include: i) identifying conflicts of interest between the firm’s consulting function and any audit responsibilities; ii) outsourcing only at appropriate times to comply with crucial due diligence standards; iii) honoring all confidentiality agreements, especially with respect to newly gathered information; and iv) recording actions taken to maintain compliance and determining who has access to records.

Organizations are under considerable pressure to provide accurate, comprehensive, and timely data on the ESG impacts of their businesses, products, and services. Engaging help from their tax & accounting firm, which already prepares their accounts, might appear to be an obvious solution to the problem, but organizations must bear in mind the focus of the recent audit reforms, acknowledge that the nature of the relationship is changing, and implement controls accordingly.

Every year, Thomson Reuters surveys accounting firms and tax leaders from around the world to find out their strategic priorities for the coming year and how firms plan to implement those strategies. The results of the latest survey are presented in Thomson Reuters 2023 State of the Tax Professionals Report, an in-depth analysis of the strategies, trends, concerns, and challenges that tax professionals are facing in 2023 and beyond.

This year’s report is based on a survey of more than 500 accounting firms from the United States, United Kingdom, Canada, Argentina, and Brazil. The survey respondents are firm owners and leaders (partners, directors, or managers), as well as tax professionals in non-leadership roles. Accounting firms of all sizes participated in the survey, but participation was highest from small and midsize accounting firms.

You can download a full copy of the 2023 State of the Tax Professionals Report here.

The report goes deep into what strategies tax & accounting firm leaders said they are prioritizing in 2023, why technology and automation play such an important role in these long-term strategic plans, and how firms intend to streamline their operations to remain competitive. The report also examines the impact of a possible recession on leadership decision-making, and why effective leadership is so important right now.

Further, the report looks at why efficiency has re-emerged as a top priority for many clients, which in turn has made it a priority for many tax & accounting firms; indeed, the report details those specific tax services that clients say they want, and how some firms are providing those services.

Talent also is a top area of concern for tax & accounting firm leaders, and those surveyed share insight on why they think quality talent is so hard to find and retain. The report also examines what types of firms are hiring and for what positions.

New year, new priorities

The overall theme of the 2023 State of the Tax Professionals Report is “a re-shuffling of priorities,” because it’s apparent from the survey results that tax & accounting firms are thinking differently now than they were a year or two ago.

In the previous year’s report, for example, the top strategic priority worldwide was finding and developing quality talent. Back then, a wave of early retirements (the so-called Great Resignation) and a rash of senior-level job-hopping had accounting firm leaders wondering where they were going to find replacements, particularly in mid-management and senior-level positions. Those concerns are still valid, but they have been displaced heading into 2023 by a re-dedication to operational efficiency and a renewed interest in the quality and substance of the client services that firms offer.

This shift could be a sign that accounting firms are positioning themselves for growth in the face of a possible recession. Both of these strategic priorities, however, are also extensions of trends we’ve been discussing for many years — namely, the desire to optimize workflows, processes, and technology wherever possible, and the need to meet customer demand for a broader range of tax and business advisory services.

Trends in 2023

A detailed analysis of how these and other trends are likely to evolve over the course of the next year or so is an important part of the report. For example, in the area of efficiency — one that’s often cited as a priority by survey respondents — the report explores how the role of technology and automation is critical in the pursuit of greater efficiency. Underscoring this, the report notes, is the need for firms to optimize their existing tools and systems, train their teams on the technology, and designate a strong leader and champion to guide the firm’s efficiency efforts.

And in the section discussing expansion and improvement of client services, the report examines what additional tax services clients want beyond basic tax preparation and how technology, effectively deployed, can improve these client services. The report also looks at key developments such as the strategies that smaller accounting firms are using to compete with larger firms, and the alternative pricing models that many firms are considering in 2023.

More growth, please

Finally, the urge to grow was a strong stated goal for almost all tax & accounting firms in 2023, but how various firms plan to grow depends a great deal on the size of the firm and the range of opportunities and challenges presented by their current client base.

For example, the growth strategy for small and midsize firms is typically focused on trying to expand their client base, while larger firms (30 or more professionals) are more likely to focus on acquiring new clients, getting higher-value work from existing clients, expanding client services, and leveraging technological efficiencies.

The latest iteration of the Rosenberg Survey, an annual study of the CPA industry in the U.S. that’s published by consulting firm The Growth Partnership, took a look at the changing complexion of accounting firm ownership — driven by a need for capital that has raised interest among private equity firms — and the profession’s long-anticipated move toward more advisory work. (The latest survey, released in late-September 2022, relies mostly on data from the year previous.)

We spoke to Allan D. Koltin, CEO of Koltin Consulting, who contributed his insight to the report, in order to better understand these larger challenges that the accounting industry must begin to address in the coming year.

Thomson Reuters Institute: In the report, you spoke about the changing face of accounting firm ownership with the acceleration of private equity involvement and mergers & acquisitions. How do you think this will all shake out?

Allan Koltin: Clearly, this kind of change is happening in the industry, in the sense of how a larger number of accounting firms are willing to approach the market and look at strategies, such as mergers or combining with private equity firms.

It’s crazy — two years ago, I didn’t have one private equity client. Today I have more than 40, and every single one wants to enter the accounting profession. I was warned about this, as the saying goes: If one breaks the code, everyone else will want in.

Of that group, one-third only want to talk to the top 25 accounting firms (those with annual revenue of $300 million or more) — these are the heavyweights. The middleweights, they’re interested in accounting firms with revenue between $100 million and $300 million; and the welterweights are looking at firms with revenue between $10 million and $100 million. When you look at this picture and assume deals are going to happen with firms of all sizes, you will have a completely transformed profession within the next two years.

Unlike the consolidators of the late-1990s that only talked to the largest firms, today’s private equity firms appear to be talking to everyone — with one caveat: The targeted accounting firm has to be uber-profitable. The harsh reality that many accounting firms are finding out is that if you are not profitable, you won’t “qualify for the loan” because the model that private equity firms are using today requires a give-back of partner compensation, and if the firm doesn’t have excess profitability, your ultimate enterprise won’t be that high.

In the late-1990s, public companies like CBIZ, H&R Block and American Express entered the accounting industry as CPA acquirors, of those only CBIZ made a lasting go of it. What the other big consolidators ultimately found out was that their program was great for the old guard, who could immediately monetize their goodwill, but for the younger professionals there wasn’t much stickiness keeping them with the organization.

Enter today’s private equity firms, which came in saying, What can we do to make this work for the younger partners? They also put something new on the table, a new type of currency called rollover equity, which became a game-changer for those younger partners.

Thomson Reuters Institute: How does that work?

Allan Koltin: The way that works is that the younger you are, the more rollover equity you’re going to get. So, the older group gets cash, and the younger group gets some cash but more rollover equity.

It’s a new generation today. When I talk to a 35-year-old partner, they said that under the old deal, they’d have to stay until they’re 65 to unlock the first $1 of deferred compensation, and then get small payments for 10 years after that — and that money would then be taxed as ordinary income. And if you look at the present value of that number today, they add, it’s “not even lunch money” — and that’s assuming both the firm and the profession are still around in 35 years.

Under today’s private equity deal, they would likely to get a substantial check with capital gains treatment right away, and then get another in three to five years, provided the firm hits some basic EBIDA performance goals. Then, in years five to seven, when the private equity group sells its investment, these partners would get a third bite of the apple by deciding whether to sell as well. In fact, their rollover equity would be pari passu, giving them the same rights and opportunities as the private equity group itself.

That means, at the young age of 40-something, these partners can have money in the bank and then decide if they want to cash out further or rollover their investment into the next private equity fund.

Thomson Reuters Institute: As we discussed in the first part of our interview, the report called technology the linchpin of almost every other discussion point in the report. But you said it may be difficult to address the technology question without first addressing the capitalization question. In short, where is the money for tech investment going to come from? Is this what is driving the push toward merger and private equity solutions?

Allan Koltin: Exactly, this is a big reason why a private equity firm is in these discussions today. The need for tech investment and digitization at many accounting firms — what I call the fourth industrial revolution — is hitting the accounting profession right between the eyes. Compliance-only shops won’t survive this because technology is replacing them. Further, this comes at a time when the younger generation of accountants is pushing back on performing the mundane work that they are often required to perform, making technology even more of a must-have.

That has firms realizing that they will need more capital to operate — so they’re looking for that capital. And that leaves them wondering if they should use their own capital and accept lower partner compensation, go to the bank and add debt to the balance sheet, or seek an investment from a private equity firm.

Every firm should engage in a simple strategic planning exercise to assess their capital needs and the vision of what they want to build. Do they want to build a firm of the future? Or just milk the firm they have until they can no longer do that. Look at your talent, look at the changes happening in your part of the industry, and figure it out.

Once you conduct this exercise, you may be open to the idea of combining with somebody bigger, which could be private equity firm or a larger CPA firm, if they are culturally and strategically aligned with your firm and are built to last, meaning they are profitable and have built out the suite of consulting or advisory services that clients want and need. It also means that they have deep pockets to continue to invest in the talent, technology, and transformation needed to be successful in today’s market.

Thomson Reuters Institute: Speaking of that, the report also noted that the long-anticipated move toward more advisory work, rather than just compliance work, was quickening. In your opinion, is it moving fast enough? If not, what can firm leadership do to accelerate it?

Allan Koltin: There’s an expression I use, The operation was successful, but the patient died — and I think that’s what’s going on in the accounting profession.

At the base of it, tax & accounting firms create two products — audits and tax returns — that clients, if you think about it, don’t necessarily want but surely need. What’s happened now, however, is there is some separation in the marketplace because a lot of firms are investing deeply in creating the firm of the future, one versed in consulting & advisory and outsource-related services.

Firms should ask their clients what they want — clients don’t care about tax returns, they want real and meaningful tax planning, whether we call that estate planning, wealth preservation, personal financial planning, or anything else in that suite of related services.

Too many accountants and their firms are still stuck in the old way of grinding out compliance products. But eventually, this work will be commoditized, and the hours spent doing it will begin to evaporate. Still, too many are blind to the situation at hand, in part because the feeding at the trough right now is really good, and many firms have had back-to-back years of profitability. (Although most partners will confess that they’re wearing themselves out with working hours because they can’t find the talent to help with the work.)

Yet despite the good times, if your firm is not investing deeply in talent, technology, and the transformation of your business, then in a couple of years you’re going to have a big problem.

The policies vary by company, of course, Disney is requiring employees be back in the office at least four days per week; while other companies are mandating a set number of days but allowing employees to choose which days they come to the office.

This all begs the question, why? Many studies and surveys have reported that productivity did not decline during an extended period of remote working, but rather went up. And employees were grateful for the ability to have more control over their schedule and work location, allowing them to craft a better work/life balance for themselves.

Leaders requiring a return-to-office mandate cite the need to reconnect teams, foster greater collaboration, and create equity for those who cannot work from home. Many of these concerns have been voiced by leaders of tax & accounting firms as well.

Accountants return to the office

So, are tax & accounting firm leaders implementing similar policies? To answer that, let’s look at a recently published report, The 2022 ConvergenceCoaching, LLC® Anytime, Anywhere Work (ATAWW) Survey. This comprehensive report examined the adoption of flexible work practices in 216 accounting firms across the country and reported significant increases in adoption and expansion of access to remote and flex work programs.

Of the 216 accounting firms that participated in the 2022 ATAWW Survey, 97% allowed their talent to choose where they work, while 94% offer flexibility in when people are working. The report notes that with more firms leaning into outsourcing, offshoring, and fractional staffing resources, it is increasingly important to learn to work asynchronously across multiple time zones. The survey also shows that surveyed firms are leveraging gig-based workers (30%), domestic outsourcing teams (30%), and overseas offshoring providers (35%).

With an increasingly tight talent pipeline, the report illustrates that leaders need to get innovative on staffing their teams. In fact, the 2022 ATAWW Survey found that “81% [of survey respondents] hired at least one remote team member they had not employed before,” which essentially means that firms are hiring new staff in their remote geography. It’s remarkable to note that this result was up from 38% in 2020.

Tax & accounting firm leaders are also eliminating outdated mandates to work Saturdays during peak seasons. In fact, 73% of responding firms now make Saturday hours optional, giving their talent the ability to choose when they will complete the extra workload required during busy seasons, the survey found.

Outside of peak periods, firms are implementing creative ways to give their talent a collective break. Almost half (47%) of survey respondents close their office on Fridays, while another 11% remain open and rotate which employees can take the day off. And just 1% of the respondents said they provide Fridays off all year round.

With the discussion of the four-day work week increasing — for example, Maryland has a proposed bill to encourage employers to offer a four-day work week — many firms are offering these kinds of benefits to be more attractive to talent.

Extending more benefits

Unlimited paid time off (PTO) is another benefit that is being discussed across the tax & accounting industry. “Unlimited PTO programs emphasize a culture of flexibility built on personal responsibility and mutual trust,” the survey notes, adding that accounting firms that offer this benefit rose from 11% in 2018 to nearly one-fifth of participants (19%) in 2022.

In fact, these benefits are being extended to all levels of client-facing staff as well as administrative and operations personnel. This level of flexibility “works for partners to administration — it works for everyone,” says Renee Moelders, ATAWW Survey co-author and Partner at ConvergenceCoaching. The 2022 ATAWW Survey found that 83% of participants offer these flex options to some or all of their operations and administrative talent as well. With cloud access, paperless documents, and revised workflows, it makes sense that all team members would be offered the option to work remotely or in a hybrid fashion.

Based on the ATAWW Survey data, it’s clear that there is a growing commitment in tax & accounting firms to extend more flexibility to their talent. And those firms embracing more flexibility will have a competitive edge in hiring and retaining top talent, while those holding onto more traditional models of work are at risk of facing greater staffing challenges going forward, warns Moelders.

Of course, there are still many challenges around greater flexibility that tax & accounting firm leaders still have to address, such as how they will ensure team collaboration, how they will train and teach remote team members, and how can they keep a remote team on track.

The answers to these challenges will take innovation and intentionality to implement and execute, but it can be done. When the pandemic hit, tax & accounting firm leaders were forced to find new solutions to keep their practices running while ensuring safety for team members and clients. Now, it is time to reignite that creativity and look at remote and flex work as a long-term solution.

Firm leaders shouldn’t let the headlines about return-to-office mandates lull them into thinking their talent will willingly accept such policies. Tax & accounting practices are well-equipped technologically to offer firm talent these flexible options, and leaders need to expand their thinking on flex and remote work so they can make their firm a destination workplace that will attract top talent.

Think of all the information you receive from your clients during your busiest time of the year — tax season — as a treasure trove. Indeed, the chance to deepen your relationships with clients while growing your business is buried within all that information and data.

Most tax firm leaders recognized that the growth of their firms requires going beyond Form 1040-work. Tax process automation has made it much simpler to do tax preparation on a larger scale, which means that tax firms can take on more clients to do more tax work. However, this provides only seasonal profitability.

Maximizing profitability requires leveraging all your firm’s knowledge to help clients succeed in their individual businesses. Becoming a business partner to clients not only deepens the relationship, but for tax firms, it can transform their businesses into advisory service firms while allowing staff a chance to engage in new work and broaden their skills, which hopefully leads to more job satisfaction.

The art of start: Who, when & how?

Deciding to do anything new or different can be exciting and nerve-racking as one struggles to determine what roadmap to use. Tax firm leaders may be tempted to roll out the new offering of advisory services to new clients, but the best place to start is with current customers. The main reason is that you have their historical data, which allows you to identify any changes and trends quickly.

First, to make sure everyone is on the same page, firm leaders should meet with the entire staff, says Pamela Butler, a Senior Consultant in Tax & Accounting Services at Thomson Reuters. “Partners at the top are maintaining a relationship, but the staff are touching the clients’ work papers and getting the inside view of what is happening with that client’s business,” Butler explains.

Each role within the firm tends to interact with the customers’ information differently and therefore has diverse perspectives on what might constitute an opportunity for more business. In addition, clients themselves might ask different staff members different questions, which would again provide a chance to identify a potential opportunity.

Tas & accounting firms should realize that finding and assessing such potential opportunities for new business can occur at any time, but is especially prevalent as tax season approaches. As clients submit their tax documents, accounting staff can look for any information that may point to an opportunity to offer the client specific advisory services.

Further, the process for how staff captures such opportunities should be simple, as you want to encourage staff members not to feel like it is too much work during an already busy and stressful time. To encourage staff participation, creating a less cumbersome process can be the key. In fact, the process for capturing opportunities can be as simple as having each person do one of the following:

• • • jot down notes (clearly the least efficient, as the notes can get lost);
    • utilize a shared Excel document in which each person can enter their suggestions; or
    • use a document management system (most ideal) as will have all of your clients’ information in one place, making it easy to track and reference.

How are you unearthing the treasure? 

So, how do you start identifying these advisory opportunities in the mountains of data and client information that you collect?

Butler provided some simple areas that might best yield business opportunities within clients’ documents. For example, if your accounting firm offers payroll services and you start seeing the last name of the business owner among other individual in the payroll, you could inquire if there are other family members working for the business, and whether perhaps some of those family members are their younger children.

“There may be strategies to implement with more favorable tax outcomes when hiring family members or children who can earn lower taxed income,” Butler says.

Moving to inform clients

Tax preparation time is not the best time to bring up your findings and enact your new advisory services, of course. Clients may be very busy during this time too. When sitting to review taxes with their clients, however, accounting firm partners should be encouraged to highlight one or two items that had been gleaned from the client’s information.

The partners can then let the client know they’ll reach out at a later time to discuss these items in much more detail. This sets the expectation that the firm will reach out after tax season to further discuss the opportunity to implement the strategy.

For enterprising tax & accounting firms, business opportunities may abound in the information that clients provide to you during your busy tax season. And once you’re past the tax deadline, you should leverage what you’ve already learned about your clients’ businesses and expand your advisory services in the direction you want to go.