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Auditors navigate a state of ‘permacrisis’

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Richard Chambers is seeing a neverending series of crises confronting internal auditors and posing risks to their organizations.

A former chairman of the Institute of Internal Auditors, Chambers currently chairs the UNICEF Audit Advisory Committee and is senior advisor of risk and audit at the audit technology company AuditBoard. His fourth book, “Connected Risk: Conquering the Perilous Risk Exposure Gap,” was published last month.

“The premise behind the book, and it’s something I’ve been talking about now for the better part of the last three years, is that it’s almost like when the 2020s dawned,” he told Accounting Today. “The switch was flipped in terms of risk, volatility and risk velocity.”

Richard Chambers NAU image

Richard Chambers

With a consequential election approaching, potential risks are top of mind for many voters. “Risks became much more volatile and unpredictable, and the speed with which they emerged became almost unfathomable,” said Chambers. “We’ve lurched from the pandemic to supply chain disruption to macroeconomic turbulence, to wars in Europe, wars in the Middle East. All of this has the combined effect of really challenging even the best risk managers out there, and the idea that risk managers can do their thing off in their silo.”

The election will bring its own set of risks. “Each party has clearly staked out its position on fiscal policies, tax policies and so forth,” said Chambers. “There’s a lot of uncertainty there as to which way it’s going to go, so you’ve kind of got to manage the risks in both directions. You’ve just got to be prepared for the.uncertainty that lies ahead.”

Internal auditors, risk managers and compliance professionals can no longer operate separately.  “We are dealing with almost an existential threat to a lot of companies and a lot of industries,” said Chambers. “We’ve seen a lot of companies and industries be decimated in the last five years,” said Chambers. “What I’ve tried to do with the book is to offer a path forward. It’s in some ways a call to action that says, you know you can’t manage risks like you’ve traditionally managed them in the era of ‘permacrisis.'”

He sees it as a permanent state of crisis where everyone needs to get involved. “It’s all hands on deck,” said Chambers. “You’ve got to have the risk managers, the internal auditors, the compliance team, the information security professionals, everybody’s got to be on the same page. And there’s got to be a lot more collaboration, cooperation and communication to help companies manage the risks.”

Chambers experienced his own crisis in 2022 when his home in Florida was badly damaged by Hurricane Ian. He was only able to move back in this past June. 

Cybersecurity and artificial intelligence open up a new set of challenges. “If I were to talk about, the top-of-mind risks in 2025, there’s a whole range of IT risks: cybersecurity, data security risks, increasingly AI,” said Chambers. “AI presents extraordinary opportunities, but it also is laced with some really significant risks. That’s going to become even more acute as we see more and more regulations put in place, legislation and regulations coming from governments to try and tie down how AI is used, to make sure it’s not misused.”

In addition, there is economic uncertainty around inflation, while recruiting is still a problem for many companies. “We’re still not out of the woods on talent management, the ability to recruit and retain the talent a company needs or an organization needs, has been in the top five for almost the whole decade so far,” said Chambers. 

Internal auditors will be hard pressed to deal with all of these uncertainties. Chambers sees a “risk exposure gap” in the number of risks that are being presented to a limited number of auditors. “We’ve seen the risk continue to mount, but we have not seen a real increase in the resources to tackle those risks,” he said. “Internal audit resources have been stagnant at best. I personally think they’ve been in a modest decline for the last two or three years because they haven’t been keeping pace with inflation. You are seeing a lot of infusion of resources into risk management or into compliance.”

One way to offset some of the risk exposure gap is through better collaboration among various risk management professionals, along with more investment in up-to-date technology. “If everybody’s still trying to track risks and manage risks using spreadsheets, that’s really not going to be very effective in the volatile environment we’re living in,” said Chambers.

He wants to see more collaboration among internal auditors, risk managers, compliance professionals and information security personnel. “I often encourage the internal auditors to be the leaders in this collaboration movement,” said Chambers. “Start working more closely with the risk managers in your organization and with the compliance teams, in making sure that when you all get in front of the board or in front of the executive management, that you have a pretty good understanding of what the others are doing, that you have hopefully been able to align on what the true risk profile is of your company. There’s nothing that frustrates a board more than having two or three different folks come in and tell them that there are different risks that the company’s facing. I’ve had audit committee chairmen say we just throw them out and tell them to come back when they can find some common ground. There’s too much ambiguity out there anyway, and if a board has ambiguity in terms of their different key players coming in and telling them that the company’s facing different risks, it really leads to frustration. The key here is there’s no one player that has to be the one to take the lead. But if somebody’s going to take the lead and get everyone on the same page with risk management, I think internal audit’s a prime candidate.”

He sees the various risks multiplying now. “I’ve been in the profession for 50 years,” said Chambers. “Next year will be my 50th year since I joined internal audit right out of college, and I’ve never seen a period as volatile as these last five years. We have been averaging as many risk disruptive events per year as we used to see in a decade. The time has come for action and the key risk management players — the risk managers, internal auditors, compliance, infosec — the ball is in their court. If companies are going to navigate the second half of this decade with any degree of success, these players have to come together and be a part of it.” 

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Senate unveils plan to fast-track tax cuts, debt limit hike

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Senate Republicans unveiled a budget blueprint designed to fast-track a renewal of President Donald Trump’s tax cuts and an increase to the nation’s borrowing limit, ahead of a planned vote on the resolution later this week. 

The Senate plan will allow for a $4 trillion extension of Trump’s tax cuts and an additional $1.5 trillion in further levy reductions. The House plan called for $4.5 trillion in total cuts.

Republicans say they are assuming that the cost of extending the expiring 2017 Trump tax cuts will cost zero dollars.

The draft is a sign that divisions within the Senate GOP over the size and scope of spending cuts to offset tax reductions are closer to being resolved. 

Lawmakers, however, have yet to face some of the most difficult decisions, including which spending to cut and which tax reductions to prioritize. That will be negotiated in the coming weeks after both chambers approve identical budget resolutions unlocking the process.

The Senate budget plan would also increase the debt ceiling by up to $5 trillion, compared with the $4 trillion hike in the House plan. Senate Republicans say they want to ensure that Congress does not need to vote on the debt ceiling again before the 2026 midterm elections. 

“This budget resolution unlocks the process to permanently extend proven, pro-growth tax policy,” Senate Finance Chairman Mike Crapo, an Idaho Republican, said. 

The blueprint is the latest in a multi-step legislative process for Republicans to pass a renewal of Trump’s tax cuts through Congress. The bill will renew the president’s 2017 reductions set to expire at the end of this year, which include lower rates for households and deductions for privately held businesses. 

Republicans are also hoping to include additional tax measures to the bill, including raising the state and local tax deduction cap and some of Trump’s campaign pledges to eliminate taxes on certain categories of income, including tips and overtime pay.

The plan would allow for the debt ceiling hike to be vote on separately from the rest of the tax and spending package. That gives lawmakers flexibility to move more quickly on the debt ceiling piece if a federal default looms before lawmakers can agree on the tax package.

Political realities

Senate Majority Leader John Thune told reporters on Wednesday, after meeting with Trump at the White House to discuss the tax blueprint, that he’s not sure yet if he has the votes to pass the measure.

Thune in a statement said the budget has been blessed by the top Senate ruleskeeper but Democrats said that it is still vulnerable to being challenged later.

The biggest differences in the Senate budget from the competing House plan are in the directives for spending cuts, a reflection of divisions among lawmakers over reductions to benefit programs, including Medicaid and food stamps. 

The Senate plan pares back a House measure that calls for at least $2 trillion in spending reductions over a decade, a massive reduction that would likely mean curbing popular entitlement programs.

The Senate GOP budget grants significantly more flexibility. It instructs key committees that oversee entitlement programs to come up with at least $4 billion in cuts. Republicans say they expect the final tax package to contain much larger curbs on spending.

The Senate budget would also allow $150 billion in new spending for the military and $175 billion for border and immigration enforcement.

If the minimum spending cuts are achieved along with the maximum tax cuts, the plan would add $5.8 trillion in new deficits over 10 years, according to the Committee for a Responsible Federal Budget.

The Senate is planning a vote on the plan in the coming days. Then it goes to the House for a vote as soon as next week. There, it could face opposition from spending hawks like South Carolina’s Ralph Norman, who are signaling they want more aggressive cuts. 

House Speaker Mike Johnson can likely afford just two or three defections on the budget vote given his slim majority and unified Democratic opposition.

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How asset location decides bond ladder taxes

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Financial advisors and clients worried about stock volatility and inflation can climb bond ladders to safety — but they won’t find any, if those steps lead to a place with higher taxes.

The choice of asset location for bond ladders in a client portfolio can prove so important that some wealthy customers holding them in a taxable brokerage account may wind up losing money in an inflationary period due to the payments to Uncle Sam, according to a new academic study. And those taxes, due to what the author described as the “dead loss” from the so-called original issue discount compared to the value, come with an extra sting if advisors and clients thought the bond ladder had prepared for the rise in inflation.

Bond ladders — whether they are based on Treasury inflation-protected securities like the strategy described in the study or another fixed-income security — provide small but steady returns tied to the regular cadence of maturities in the debt-based products. However, advisors and their clients need to consider where any interest payments, coupon income or principal accretion from the bond ladders could wind up as ordinary income, said Cal Spranger, a fixed income and wealth manager with Seattle-based Badgley + Phelps Wealth Managers.

“Thats going to be the No. 1 concern about, where is the optimal place to hold them,” Spranger said in an interview. “One of our primary objectives for a bond portfolio is to smooth out that volatility. … We’re trying to reduce risk with the bond portfolio, not increase risks.”

READ MORE: Why laddered bond portfolios cover all the bases

The ‘peculiarly bad location’ for a bond ladder

Risk-averse planners, then, could likely predict the conclusion of the working academic paper, which was posted in late February by Edward McQuarrie, a professor emeritus in the Leavey School of Business at Santa Clara University: Tax-deferred retirement accounts such as a 401(k) or a traditional individual retirement account are usually the best location for a Treasury inflation-protected securities ladder. The appreciation attributes available through an after-tax Roth IRA work better for equities than a bond ladder designed for decumulation, and the potential payments to Uncle Sam in brokerage accounts make them an even worse asset location.

“Few planners will be surprised to learn that locating a TIPS ladder in a taxable account leads to phantom income and excess payment of tax, with a consequent reduction in after-tax real spending power,” McQuarrie writes. “Some may be surprised to learn just how baleful that mistake in account location can be, up to and including negative payouts in the early years for high tax brackets and very high rates of inflation. In the worst cases, more is due in tax than the ladder payout provides. And many will be surprised to learn how rapidly the penalty for choosing the wrong asset location increases at higher rates of inflation — precisely the motivation for setting up a TIPS ladder in the first place. Perhaps the most surprising result of all was the discovery that excess tax payments in the early years are never made up. [Original issue discount] causes a dead loss.”

The Roth account may look like a healthy alternative, since the clients wouldn’t owe any further taxes on distributions from them in retirement. But the bond ladder would defeat the whole purpose of that vehicle, McQuarrie writes.

“Planners should recognize that a Roth account is a peculiarly bad location for a bond ladder, whether real or nominal,” he writes. “Ladders are decumulation tools designed to provide a stream of distributions, which the Roth account does not otherwise require. Locating a bond ladder in the Roth thus forfeits what some consider to be one of the most valuable features of the Roth account. If the bond ladder is the only asset in the Roth, then the Roth itself will have been liquidated as the ladder reaches its end.”

READ MORE: How to hedge risk with annuity ladders

RMD advantages

That means that the Treasury inflation-protected securities ladder will add the most value to portfolios in a tax-deferred account (TDA), which McQuarrie acknowledges is not a shocking recommendation to anyone familiar with them. On the other hand, some planners with clients who need to begin required minimum distributions from their traditional IRA may reap further benefits than expected from that location.

“More interesting is the demonstration that the after-tax real income received from a TIPS ladder located in a TDA does not vary with the rate of inflation, in contrast to what happens in a taxable account,” McQuarrie writes. “Also of note was the ability of most TIPS ladders to handle the RMDs due, and, at higher rates of inflation, to shelter other assets from the need to take RMDs.”

The present time of high yields from Treasury inflation-protected securities could represent an ample opportunity to tap into that scenario.

“If TIPS yields are attractive when the ladder is set up, distributions from the ladder will typically satisfy RMDs on the ladder balance throughout the 30 years,” McQuarrie writes. “The higher the inflation experienced, the greater the surplus coverage, allowing other assets in the account to be sheltered in part from RMDs by means of the TIPS ladder payout. However, if TIPS yields are borderline unattractive at ladder set up, and if the ladder proved unnecessary because inflation fell to historically low levels, then there may be a shortfall in RMD coverage in the middle years, requiring either that TIPS bonds be sold prematurely, or that other assets in the TDA be tapped to cover the RMD.”

READ MORE: A primer on the IRA ‘bridge’ to bigger Social Security benefits

The key takeaways on bond ladders

Other caveats to the strategies revolve around any possible state taxes on withdrawals or any number of client circumstances ruling out a universal recommendation. The main message of McQuarrie’s study serves as a warning against putting the ladder in a taxable brokerage account.

“Unsurprisingly, the higher the client’s tax rate, the worse the outcomes from locating a TIPS ladder in taxable when inflation rages,” he writes. “High-bracket taxpayers who accurately foresee a surge in future inflation, and take steps to defend against it, but who make the mistake of locating their TIPS ladder in taxable, can end up paying more in tax to the government than is received from the TIPS ladder during the first year or two.”

For municipal or other types of tax-exempt bonds, though, a taxable account is “the optimal place,” Spranger said. Convertible Treasury or corporate bonds show more similarity with the Treasury inflation-protected securities in that their ideal location is in a tax-deferred account, he noted.

Regardless, bonds act as a crucial core to a client’s portfolio, tamping down on the risk of volatility and sensitivity to interest rates. And the right ladder strategies yield more reliable future rates of returns for clients than a bond ETF or mutual fund, Spranger said.

“We’re strong proponents of using individual bonds, No. 1 so that we can create bond ladders, but, most importantly, for the certainty that individual bonds provide,” he said.

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Why IRS cuts may spare a unit that facilitates mortgages

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Loan applicants and mortgage companies often rely on an Internal Revenue Service that’s dramatically downsizing to help facilitate the lending process, but they may be in luck.

That’s because the division responsible for the main form used to allow consumers to authorize the release of income-tax information to lenders is tied to essential IRS operations.

The Income Verification Express Service could be insulated from what NMN affiliate Accounting Today has described of a series of fluctuating IRS cuts because it’s part of the submission processing unit within wage and investment, a division central to the tax bureau’s purpose.

“It’s unlikely that IVES will be impacted due to association within submission processing,” said Curtis Knuth, president and CEO of NCS, a consumer reporting agency. “Processing tax returns and collecting revenue is the core function and purpose of the IRS.”

Knuth is a member of the IVES participant working group, which is comprised of representatives from companies that facilitate processing of 4506-C forms used to request tax transcripts for mortgages. Those involved represent a range of company sizes and business models.

The IRS has planned to slash thousands of jobs and make billions of dollars of cuts that are still in process, some of which have been successfully challenged in court.

While the current cuts might not be a concern for processing the main form of tax transcript requests this time around, there have been past issues with it in other situations like 2019’s lengthy government shutdown.

President Trump recently signed a continuing funding resolution to avert a shutdown. But it will run out later this year, so the issue could re-emerge if there’s an impasse in Congress at that time. Republicans largely dominate Congress but their lead is thinner in the Senate.

The mortgage industry will likely have an additional option it didn’t have in 2019 if another extended deadlock on the budget emerges and impedes processing of the central tax transcript form.

“It absolutely affected closings, because you couldn’t get the transcripts. You couldn’t get anybody on the phone,” said Phil Crescenzo Jr., vice president of National One Mortgage Corp.’s Southeast division.

There is an automated, free way for consumers to release their transcripts that may still operate when there are issues with the 4506-C process, which has a $4 surcharge. However, the alternative to the 4506-C form is less straightforward and objective as it’s done outside of the mortgage process, requiring a separate logon and actions.

Some of the most recent IRS cuts have targeted technology jobs and could have an impact on systems, so it’s also worth noting that another option lenders have sometimes elected to use is to allow loans temporarily move forward when transcript access is interrupted and verified later. 

There is a risk to waiting for verification or not getting it directly from the IRS, however, as government-related agencies hold mortgage lenders responsible for the accuracy of borrower income information. That risk could increase if loan performance issues become more prevalent.

Currently, tax transcripts primarily come into play for government-related loans made to contract workers, said Crescenzo.

“That’s the only receipt that you have for a self-employed client’s income to know it’s valid,” he said.

The home affordability crunch and rise of gig work like Uber driving has increased interest in these types of mortgages, he said. 

Contract workers can alternatively seek financing from the private non-qualified mortgage market where bank statements could be used to verify self-employment income, but Crescenzo said that has disadvantages related to government-related loans.

“Non QM requires higher downpayments and interest rates than traditional financing,” he said.

In the next couple years, regional demand for loans based on self-employment income could rise given the federal job cuts planned broadly at public agencies, depending on the extent to which court challenges to them go through.

Those potential borrowers will find it difficult to get new mortgages until they can establish more of a track record with their new sources of income, in most cases two years from a tax filing perspective. 

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