Blockchain 101

Thousands of years ago, ancient Mesopotamians first developed accounting practices for the purpose of keeping a written record of money and barter transactions. In the intervening millennia, advances in technology and theory has allowed accounting to evolve into an art and a science. The most recent “upgrade” has enabled a revolutionary overhaul of accounting as we know it.

In 2008, an unknown person (or persons) using the pseudonym Satoshi Nakamoto created the first digital currency, Bitcoin. Nakamoto’s groundbreaking whitepaper Bitcoin: A Peer-to-Peer Electronic Cash System paved the way for the establishment of a multi-billion dollar[i] global industry via a distributed database known as a blockchain.

A blockchain is a decentralized public ledger system that stores digital information chronologically in the form of “blocks.” These blocks are inherently linked (“chained”) to one another, and each block plays a role in facilitating anonymous and secure transactions between users, while providing monetary rewards to those who help maintain the public ledger. This chain of blocks contains a record of every single transaction ever in the history of a given cryptocurrency (“coin”). Cryptocurrency coins are virtual assets created by the process of “mining,” which is essentially the process of a computer algorithm solving a complex mathematical equation to validate a single block of the blockchain (think of a batch of transactions), and subsequently broadcasting this record to all other computers connected to this global network (each computer being a “node”). This process creates a single distributed public ledger across thousands of nodes around the globe. If a computer is able to solve the complex equation (via “cryptography”) and prove to the network that its equation validates a block (“proof of work”), the computer’s operator is compensated with a combination of a per-block reward of newly minted coins--“block reward”--and a small percentage of the transactions contained within the block--the “mining fee.” The newly-minted miner rewards tend to decrease over time on a schedule as the monetary value of the coin tends to increase, giving cryptocurrencies an economically deflationary appeal. The monetary value of a coin stems from the active trading between users on public coin exchanges. Technically, cryptocurrency mining creates inflation; however, using Bitcoin as an example, the inflation is controlled. For example, the mining reward for successfully “solving” the first ever block started at 50 Bitcoins, and at every 210,000 blocks (approximately every four years) the mining reward is cut by 50%, up to a total maximum supply around 21,000,000 Bitcoin. As of July 31, 2017, we are currently in block #478446, and the mining reward today is 12.5 Bitcoin (equivalent to approximately $35,000).

The revolutionary aspect of blockchain technology rests in the triple entry accounting concept. Triple entry accounting tweaks the double entry by including a cryptographic seal by a third entry. Today, a seller and a buyer maintain two separate sets of accounting records. A seller books a debit to account for cash received, while a buyer books a credit for cash spent in the same transaction. This is where the blockchain comes in. Rather than these entries occurring separately in independent sets of books, they occur in the form of a transfer between “wallet” addresses within the same distributed public ledger. This process creates an interlocking system of enduring accounting records. Because the entries are distributed and cryptographically sealed, falsifying them in a credible way or destroying them to conceal activity is practically impossible. How it is impossible, well… keep reading!

 
 

Transactions (i.e., transfers of coins from one party to the next) are recorded in blocks on the blockchain. Depending on the coin in question, the size of a block is usually fixed to either the total number of kilobytes or megabytes of transaction data contained within (which is merely a bunch of alpha-numeric characters), or simply a predetermined length of time containing all transactions falling within that time span. Today, there are hundreds of cryptocurrency coins, each with their own unique blockchain and their own unique characteristics as defined within the open-sourced codes of their respective mutually agreed upon distributed algorithms. The total number of cryptocurrencies increases daily.

To visualize a blockchain, imagine a hierarchal grouping of folders on a hard drive. Each block, or sub-folder, within the root “Blockchain data” folder essentially contains a batch of time-stamped transactions representing every transaction of a given cryptocoin over a small span of time, from numerous anonymous parties to the next anonymous parties. All of this data is publicly available and searchable either by block number, transaction ID, or wallet address. Using the example above, the Block002 sub-folder contains a reference to Block001’s encrypted validation code. The encrypted code for Block001 must be incorporated into the encryption of the Block002 validation code by the miner validating the block, along with the encryption of every transaction within Block002, for the block to be considered validated (thus creating a running chain of encryption and validation). This chronological validation process computed by the miners proves not only the validity of the Block002 and all its contents, but also every single block preceding it. Throughout the validation process, miners stamp on their digital signatures documenting their witness and confirmation of the activity on Blockchain. It’s important to note that the miner validation for each block is competitive around the globe. This is due to the high monetary reward for successfully solving the equation. This intense competition renders it highly unlikely for the same individual to validate the two or more times in a row.

This is how the blocks become a chain. Because the system is managed by a peer-to-peer network collectively adhering to a validation protocol, the system is inherently resistant to modification of the data. Once recorded, the data in any given block cannot be altered retroactively without the alteration of all subsequent blocks and a collusion of the network majority. Blockchains can be used to facilitate any financial transaction between multiple parties—not just cryptocurrencies, but transactions in real estate, ordinary property, and financial securities.

What makes a blockchain truly valuable, especially from an accounting perspective, is that each block has a unique identifier. In any given transaction, the unique identification of each party involved is auditable. This unique identification system creates a transparent and verifiable path documenting the historical transfer of value from one individual wallet to the next. Similar to the process of an auditor confirming a cash balance with the bank directly, an accountant could verify a transaction or the balance of a wallet across hundreds of independent, yet identical ledgers.

 

Curious to know more? Click here for a quick primer on blockchain terminology.

 

Due to the blockchain concept’s relative novelty, authoritative regulatory bodies have yet to create blockchain policies specific to the industries they operate in. The IRS’s position on virtual currency (cryptocurrency) in their IRB 2014-16 in April 2014 maintains that for federal tax purposes, virtual currency is treated as property. In June 2017, the Chamber of Digital Commerce petitioned FASB to determine the appropriate recognition, measurement, presentation, and disclosure for digital currencies. This petition considered four different accounting topic methods under which digital currencies could fall (ASC section’s 305, 330, 350 and 825), but no guidance to define exactly what a digital currency is. In July of this year, Accounting Today discussed key foundations that need to be in place before fully adopting blockchain to meet business needs. Among them are standards to be set by the auditors who must rely on the system as audit evidence.

Ethereum is the second largest cryptocoin by market capitalization, but it’s much more than a digital currency. Ethereum helped organize the world’s largest open-source blockchain initiative, the Enterprise Ethereum Alliance. Its purpose is to build a clear roadmap for businesses to learn and leverage the technology and to provide governance for enterprise accountability, features, and licensing models. One of the systems they have helped implement is the smart contract.

A smart contract follows the same principles as a cryptocurrency transaction, but you can layer condition-based code to facilitate, verify, or enforce the negotiation or performance of a variety of financial and non-financial transactions. This effectively and efficiently eliminates a lot of the paperwork and middle-man responsibilities in the world today. Many Fortune 500 companies have already invested billions of dollars in this technology and are members of this organization (e.g., J.P. Morgan, Intel, UBS, Microsoft, ING) who recognize the impact this technology will have on their specific industries and the marketplace. Deloitte and PwC (and now Raich Ende Malter) have started ThinkLab groups in their practices and are working diligently in developing strategies to employ using blockchain.

What does all this mean for us as auditors and tax preparers? Stay tuned—we’ll explain in a future post.

Are you involved in cryptocurrencies? Thinking of getting involved? Contact your trusted advisor, or talk to us at REM.

Special thanks to The Geek Group of Grand Rapids, Michigan, for vetting.

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Social security benefits: timing is everything

Posted by Joseph DeMartinis, CPA

I was talking to a client a few weeks back who said to me, “What do I care? I get a raise at 62 anyway.” He was referring to filing and receiving his social security benefits at age 62 instead of waiting until his full retirement age (FRA). I had to quickly run through a few different scenarios with him and discuss why taking the benefits now instead of waiting may have an adverse effect on his long-term goals. It really resonated with me and made me wonder how many people have the same mindset as that client.

The basics

If you’re employed or self-employed, you are most likely paying into your social security benefits. In order to qualify for benefits when you retire, you need to have worked and paid into the social security system for 40 quarters, or 10 years. Your benefit is calculated based on a ratio of your 35 highest years of earnings, using zeroes for any year in which you did not work. There are spousal and survival benefits available, and even if divorced, you may qualify for benefits based on a former spouse’s earnings (restrictions may apply).

Back to the example

Now that we know the basics, let’s jump back to the example I mentioned earlier about my client taking benefits at 62. We will have to make a few assumptions in order to paint a proper picture. Putting aside whether or not there will be a social security system still around when my client retires (that’s a different conversation), let’s assume his FRA is 67 (this is important) and that he will live until 90 (lucky guy!). His FRA benefit is expected to be $24,000 a year, and for the sake of simplicity, we’ll assume no annual cost of living adjustment (COLA). Is this unrealistic? Probably – but there have been three years since 2010 with no COLA. We will also assume he is single and NOT working during the time period discussed, as working while collecting social security benefits can decrease the amount of benefits received.

If he begins collecting at 62 with an FRA of 67, he will have a 30% permanent reduction from his social security benefits. If he takes his benefits at 67 there will be no reduction, and if he waits until 70, he will receive a 24% increase in his benefits.

Breakdown of his monthly benefits

 
 

Approximate total payments he would receive over the course of his lifetime

 
 

Summary of his break-even ages when comparing the different options

 
 

As you can see from the information above, the various break-even points are ages that need to be reached in order for my client to receive the advantage of holding off on receiving his benefits. If he lives until age 78, then it was the right choice for him to hold off his benefits from 62 to 67, and if he lives until 82, then it was the right choice for him to hold off his benefits from 67 to 70.

(I’m not sure I need a disclaimer for a blog post, but obviously the example above was for illustrative purposes and should not be relied upon as a guarantee of benefits. Changing any of the variables above can have a drastic effect on the outcome of the example.)

So what's the right answer?

It depends. I know that seems like a cop-out answer, but in order to know the right answer there are a host of variables that must be discussed with your advisors. Your health, lifestyle, family situation, and need/desire for the income all become factors that must be discussed and prioritized in order to maximize the benefits that you can receive.

No one has a crystal ball. When it is time to start thinking about filing for social security, you should reach out to your accountant and other trusted advisors to weigh your options.

Legal note: Contributors to The REM Cycle are certified public accountants (CPAs), but they’re not your CPAs and this blog does not create or constitute an accountant-client relationship. Contributors are licensed to practice public accountancy in New York State and have based the information presented on U.S. and, where applicable, state laws. All content provided on this blog is for informational purposes only, and should not be seen as accounting advice. Raich Ende Malter & Co. LLP (REM) makes no representations as to the accuracy or completeness of any information on this site or found by following any link on this site. REM will not be liable for any errors or omissions in this information, nor for the availability of this information. REM will not be liable for any losses, injuries, or damages from the display or use of this information. These terms and conditions of use are subject to change at any time and without notice. You should consult with a CPA before you rely on this information.

TRUMPWATCH 2017: 100 days of uncertainty

Posted by Evan Piccirillo, CPA

Over the last 100 days, we have seen our new President push for many things in any number of directions.  The repositioning of certain postures taken during the campaign has ranged from slight to drastic.  This in consideration, one word to best sum up the actions of the current administration might be “unpredictable.”

The Republican Party currently controls the executive and legislative branches of government and has long taken issue with current tax law.  With both the means and impetus to achieve meaningful tax reform, the stage was set for quick and sweeping changes to the U.S. tax code.  Many experts were predicting just that: a tax overhaul, effective January 1, 2017.

Last week, the Trump administration, through Treasury Secretary Mnuchin and National Economic Director Cohn, reaffirmed its intent to reform the U.S. tax code.  The stated purpose of the plan is to lighten the financial burden of U.S. taxpayers, promote economic growth, and simplify compliance… and not add to the deficit.  In a word: Huge.

The plan has been called many things by pundits and news organizations, ranging from “a disaster” to “the savior” of the administration.  The White House describes it as “the biggest cut ever” and “phenomenal.”  Many arguments have been presented over the potential fallout of such reform, as citizens try to predict:

© Matthew Woltunski via Flickr

© Matthew Woltunski via Flickr

  • Will this increase the deficit?
  • Will the tax cuts make up for the difference in tax revenue on their own by stimulating economic growth?
  • Who will benefit most—the wealthy, the poor, me (one can only hope)?
  • Can’t we please forget about the AMT?
  • And of course, will the reform disproportionately help the President’s personal tax burden?

Unfortunately, those questions will continue to go largely unanswered.  The full nature and impact of Trump’s tax reform policy is still hard to ascertain.  Very little in the way of detail has been given to the major bullet points of the plan – in fact, the proposal presented last Wednesday was only one page in length and lacked any true elaboration.

To the administration’s credit, their position on tax reform has not changed drastically from what was put forth on the campaign trail (read about that here); however, the message needs to be clarified to sufficiently inform the American people.  Seeking that clarity, most have looked to the conservative tax blueprint drawn up by Kevin Brady and Paul Ryan, but we have already seen the President and others in the party sour to that plan, specifically the border adjustment tax proposed therein.

In spite of the 100-day timeframe, it is still impossible to gauge Trump’s tax reform policy with any degree of accuracy.  Perhaps the next 100 days will bring potential tax reform into better focus, but many of the experts I mentioned earlier are pushing expectation of anticipated tax reform back to 2018.  Additionally, in-fighting among factions of the GOP could delay new law for even longer than that.

For now, we will all have to deal with the Code as it is and wait anxiously to see if any changes are in store for the future.  Sad.

Tick-tock on the tax clock

How accountants feel the day after tax deadline. Wikipedia

How accountants feel the day after tax deadline. Wikipedia

Posted by Evan Piccirillo, CPA

Time constraints coupled with the sheer volume of work makes tax season an incredibly stressful time for taxpayers and tax preparers.  Taxpayers will have to compile all of their tax information for the prior year and send it over to their accountant who will no doubt have a series of uncomfortable, probing questions.  The ever-present apprehension of having to write a large check looms overhead like a coming storm.  Tax preparers will spend countless hours poring over tax documents and IRS code sections trying to efficiently turn around tax returns, leaving no deduction or credit on the table.  The late nights and delivery food build up in preparers’ systems and erode their constitutions transforming them into mere husks of their former selves.

As each grain of sand runs through the hourglass, it feels as if the noose is tightening.

For taxpayers, the procrastination builds on itself like a cancer.  Dealing with all of this is painful, so why not put it off until tomorrow?  All of a sudden the calendar page turns and it is April 1st… not only has nothing been sent to the preparer’s office, the envelopes on many tax documents are still sealed and sitting in a pile on the desk.  In a frenzy, the documents (still sealed) are shoved into a large manila folder and mailed out, without a proper care and review.  Are some things missing?  Probably, but we have time right?  We can count on our trusted preparers!  There are still two weeks left!

For tax preparers, the work piles up and it seems impossible that there is a chance it will be completed on time.  Each day more packages arrive.  Each day the lists grow.  The arms on the clock spin at an astonishing rate.  How many returns did we get out today?  None!  This client still has open items, that client has yet to return their electronic filing authorizations, and by the way, they have a new trust return this year.  Tensions grow high and at any point a tiny spark could burst into a raging fire.  It is a marvel that we are able to maintain a level of calm in such conditions.

As the deadline comes into view just over the horizon, it feels like a blessing and a curse at the same time.  Knowing that it will soon come to an end is little solace when all one can think about is the final sprint to the finish line.  Tax preparers, many of whom have now fallen into the same rut as those for whom they are servicing, will likely still need to finish their own tax returns.  Many taxpayers are now growing anxious about making the deadline in addition to what they might owe in tax and that added stress pours like a waterfall over the preparers.

It builds and builds, panic turns to madness, the only thing fueling us is the little bit of adrenaline left in the tank.  Focus in such a torrent comes at a premium, and only the hardiest can maintain.  Frantically, the last of the returns are finalized and somehow all clients are either filed timely or on extension.  And then finally, as if waking from a nightmare, it is over.

Now that tax season is at an end, spring can truly begin.  Both taxpayers and tax preparers can breathe a collective sigh of relief and gather their wits.  Tax preparers can perhaps take some days off to be with their families, who at this point might have forgotten what they look like.  Taxpayers can worry about all of the other things in their life that need attention.  We can all forget what a test of wit and fortitude it has been until next year (actually four or five months).

So I say to you all as emphatically as I might: Happy End-of-Tax-Season!

A day in the life

iStock

iStock

Posted by Gigi Boudreaux, CPA, MBA

Editor’s Note: There is no “TrumpWatch” this month, as David Roer is busy doing what he does best – being a tax accountant. As you can imagine, we’re all pretty busy here at the REM Cycle. You’re probably aware that things are hectic for us during tax season, but what does an accountant actually do? What’s it actually like? We asked Gigi Boudreaux to explain.

I’m often asked about my life and experiences during tax season. To appease the curiosity, here’s a breakdown of a typical day for me during the height of tax season.

I arrive at work well before 9:00 AM in an attempt to get settled before the chaos begins. My office feels like I only left a few minutes ago. The only difference is me – I’m wearing different clothes, carrying a different lunch, and starting the new day with a fresh attitude. It’s going to be a good, productive day!

First thing I do every day, open my email. I have already glanced at my inbox earlier this morning, but decide to wait until I arrive at work to manage the myriad emails that arrived overnight. Most of the emails are junk. Delete! I am constantly unsubscribing, but the junk keeps coming. Do I want to rent a private jet? Really?! At least I got a chuckle out of that one. I move on to the important emails. One contains e-file authorizations I’ve been waiting for. Great! Wait – client only sent Federal authorizations. Ugh. Another email is from one of my partners, “Can you please handle a complicated issue for me? I had someone else, but I think you will handle it better and faster.” This will set me back a bit, but I’ll do my best. I hardly ever say no.

Soon after I arrive, a colleague enters my office, clearly distressed. She needs to take time off for a family issue. She says, “I know it’s tax season, but it is very important.” I tell her that family always comes first and that we will work together to make it work.

People start to arrive, coffee starts to brew, and my phone starts to ring. Calls from clients include, “Did you get my fax? Where do I sign on the e file authorization? Is my return done yet?” A call from an IRS agent, “I have been out sick for a month so I haven’t looked at your case, but now I am back. Can you get me several documents ASAP?” I reply sheepishly, “Uh…it’s tax season.” Agent: “So?” Then, I am part of a conference call with our IT department and our software provider, because all three scan machines in our NYC office are offline, which is kind of a big deal. While on the conference call, my husband calls in to see how I’m doing. I’ll call him back later.

The managing partner arrives, practically bouncing off the walls with energy and enthusiasm. Not sure I can match his energy, but he has inspired me to step it up.

A colleague (who is also a friend) emails me to say she’s made a quiche for lunch. Do I want some? Yes, of course! This will be the highlight of my day.  It’s so silly what makes me happy this time of year.

An extremely distressed coworker who has lost a tax return file calls: “Can you please help me?” I stop what I am doing and we find the return. I get enormous satisfaction from helping her.

Later in the day, I have a scheduled phone call with a client who has been waiting for my attention for a day, which is a long time to wait. I am conscious of this. It’s a long call and we address all of the issues on his list. He is happy with the advice. I hang up and wonder how I’m going to bill that time; he’s never going to pay for it. Yet, he is content and so am I.

I receive a text from my sister-in-law: “Hey, can I stop by later today to drop off my tax stuff?” I respond, “I won’t be home till very late.” She sighs, “Really? How late? I also need to use your printer to get one of my tax documents because my printer is broken.” Frustrated that she still doesn’t understand the hours I work after so many years, I suggest she come on the weekend. I know she is counting on her refund.

Client calls: “Can you tell me how much money I made? And I have several questions about my tax return.” This takes time, but by the end of the conversation, he understands and is thankful. I am happy to have helped.

My daughter texts from college: “Mom, I think I failed Logic. Can you talk?” Of course. Although I cannot make time for my husband, there is always time for her. I guess I need to work on that.

I meet with potential new client. Meeting new people and hearing about how passionate they are about their business is always exciting and interesting. It is contagious. This one looks promising, but you never know.

Okay, now it’s time to start my productive day and get down to doing work. I glance out the window and suddenly realize its dark outside. Clock reads 8:00 PM! Really?! I haven’t even addressed the first item on my daily to-do list. Well, I guess it’s going to be another long night.

The chaos of tax season is challenging and exciting and maddening all at the same time. You can see that there is so much more than simply putting numbers on a form and telling people how much money they owe to Uncle Sam. On any given day, I am an advisor, a technician, a juggler, a therapist, and a mentor. Why do I keep coming back each day? The satisfaction of being able to help others, clients and coworkers alike, truly inspires and motivates me. When I go home at the end of a long day, there is nothing better than knowing that I did something good for someone today.