and other financial statement requirements
Rev. Proc. 2016-33, section 2.05
.5 Submission of annual audited financial statements.
(1) Copy of financial statements. With its application, a CPEO applicant must submit a copy of its annual audited financial statements for the most recently completed fiscal year as of the date it submits its application, except as provided in the next sentence. If a CPEO applicant submits its application before the last day of the sixth month following its most recently completed fiscal year, and the audit of the financial statements for that fiscal year has not been completed at the time it submits its application, the CPEO applicant must provide with its application the annual audited financial statements for the immediately preceding fiscal year, and the CPEO applicant must subsequently provide to the IRS the annual audited financial statements for the most recently completed fiscal year by the last day of the sixth month after such fiscal year ends. In addition, for any fiscal year that ends after the CPEO applicant submits its application for certification and on or before the effective date of certification, if applicable, the CPEO applicant must provide the annual audited financial statements by the last day of the sixth month after such fiscal year ends. The obligations described in this paragraph continue even if the CPEO applicant is certified as a CPEO before the IRS has received the annual audited financial statements.
(2) CPA opinion. With each of these required annual audited financial statements, a CPEO applicant must submit an opinion of a CPA that such financial statements–
(a) Are presented fairly and in accordance with generally accepted accounting principles (GAAP);
(b) Reflect positive working capital (as defined by GAAP) or, only if the requirements of section 2.05(4) are met, reflect negative working capital, with the opinion in either case setting forth in detail a calculation of the CPEO applicant’s working capital as reflected in the financial statements; and(c) Reflect that the CPEO applicant computes its taxable income using an accrual method of accounting.
(3) CPA opinion must be unmodified. The CPA opinion must be unmodified (such that it cannot be a qualified opinion, an adverse opinion, or a disclaimer of opinion) and accompanied by a written declaration, signed by the CPA, that the CPA is currently qualified as a CPA and is authorized to represent the CPEO applicant before the IRS.
(4) Exception for negative working capital. A CPA opinion described in section 2.05(2) may state that a CPEO applicant’s annual audited financial statements reflect negative working capital, but in that case the opinion will meet the requirements of section 2.05(2) only if–
(a) The CPEO applicant has negative working capital for no more than two consecutive fiscal quarters of the fiscal year, as demonstrated by the required annual audited financial statements or the statements described in section 2.06(3), or the submission of quarterly unaudited financial statements;
(b) The CPEO applicant or its CPA provides with the CPA opinion a detailed calculation of its negative working capital and an explanation to the IRS describing the reason for the failure; and
(c) The IRS determines, in its sole discretion, that the failure does not present a material risk to the IRS’s collection of federal employment taxes. The determination of whether the failure presents a material risk to the IRS’s collection of federal employment taxes may depend, in part, on whether the CPEO applicant has identified facts and circumstances that will result in positive working capital in the near future.
(5) Newly-established CPEOs. A CPEO applicant that was not operating as a provider of employment-related services for all or part of the most recently completed fiscal year as of the date it submits its application for certification must also provide a copy of the audited financial statements of the following entity or entities, if applicable, for each applicable entity’s most recently completed fiscal year, accompanied by an unmodified opinion of a CPA that such financial statements are presented fairly and in accordance with GAAP and reflect positive working capital (as defined by GAAP) or, only if the requirements of section 2.05(4) are met (as applied to such entities), reflect negative working capital, with the opinion in either case setting forth in detail a calculation of the entity’s working capital as reflected in the financial statements:
(a) Any precursor entity of the CPEO applicant; or
(b) If the CPEO applicant does not have a precursor entity, any related entity described in § 301.7705-1T(b)(12)(ii)(B).
(6) Financial statements for controlled groups. In satisfaction of the requirement in paragraph (1), if a CPEO applicant is a member of a controlled group of which other members are CPEO applicants or CPEOs, the CPEO applicant must submit copies of combined or consolidated annual audited financial statements for all CPEO applicants and CPEOs in the controlled group, with an accompanying unmodified opinion of a CPA that such financial statements are presented fairly and in accordance with GAAP. The combined or consolidated annual audited financial statements may, but are not required to, also include all members of the controlled group that are not CPEO applicants or CPEOs. The statements and opinion must contain the name and EIN of each CPEO applicant and CPEO in the controlled group. If the statements and opinion include members of the controlled group that are not CPEOs or CPEO applicants, the name and EIN of these members must also be included. Although the CPEO applicant is not required to provide a copy of its separate financial statements as part of its application, if the financial position of a CPEO applicant is unclear from the combined or consolidated financial statements of the controlled group of which the CPEO applicant is a member, the IRS may request additional financial information that is needed to evaluate the CPEO applicant’s position, such as the annual balance sheet, income statement, and statement of cash flow, of the individual CPEO applicant. Notwithstanding the foregoing, and as required by section 2.05(2), a CPEO applicant that is a member of a controlled group of which other members are CPEO applicants or CPEOs must provide an opinion of a CPA that the individual CPEO applicant’s financial statements reflect positive working capital (as defined by GAAP) or, if the requirements of section 2.05(4) are met, reflect negative working capital, with the opinion in either case setting forth in detail a calculation of the individual CPEO applicant’s working capital. For purposes of the requirements of section 2.05(4), if it is unclear whether the CPEO applicant has positive or negative working capital for the last quarter of the fiscal year based on the combined or consolidated financial statements of the controlled group of which the CPEO applicant is a member, the IRS may request additional financial information on an individual CPEO applicant basis. The status of other CPEO applicants and CPEOs in the controlled group is not affected if the CPEO applicant is denied certification because the annual audited financial statements reflect that the CPEO applicant has negative working capital and the CPEO applicant fails to meet the exception described in section 2.05(4).
(7) A fiscal year will be considered completed once the last day of that fiscal year has ended, regardless of whether the CPEO applicant was in operation or certified for all 12 months of the fiscal year or the fiscal year consisted of fewer than 12 months.
§301.7705-2T(e)(1)
(e) Financial statements—(1) CPEOs. By the last day of the sixth month after the end of each fiscal year, and beginning with the first fiscal year that ends after the CPEO’s effective date of certification, a CPEO must cause to be prepared and provided to the IRS a copy of its annual audited financial statements for the fiscal year and an opinion of a certified public accountant (CPA) that such financial statements—
(i) Are presented fairly in accordance with GAAP; and
(ii) Reflect positive working capital or, only if the CPEO satisfies the requirements of paragraph (e)(3) of this section, reflect negative working capital, with such opinion in either case setting forth in detail a calculation of the CPEO’s working capital as reflected in the financial statements.
Preamble to Final and Temporary Regulations, section 3(c)
c. Financial Statements
In addition to the specific requirements with respect to financial statements in section 7705(c), section 7705(b)(1) provides that the Secretary may establish requirements with respect to annual financial audits. Pursuant to these provisions, the temporary regulations require a CPEO applicant to provide to the IRS, with its application, a copy of its annual audited financial statements for the most recently completed fiscal year as of the date it applies for certification. If a CPEO applicant applies for certification before the last day of the sixth month following its most recently completed fiscal year, and the audit of the financial statements for this fiscal year has not yet been completed at the time of application, a CPEO applicant must also provide to the IRS a copy of its audited financial statements for the immediately preceding fiscal year, if any. The temporary regulations provide that the CPEO applicant must subsequently provide to the IRS the financial statements for the most recently completed fiscal year by the last day of the sixth month after such fiscal year ends. In addition, for any fiscal year that ends after the CPEO applicant applies for certification and on or before the effective date of certification, if applicable, the CPEO applicant must provide the audited financial statements by the last day of the sixth month after such fiscal year ends. The obligation to provide the audited financial statements described in the preceding sentence continues to apply after the CPEO applicant is certified as a CPEO. Once certified, pursuant to section 7705(b)(1), a CPEO is required by the temporary regulations to provide a copy of its annual audited financial statements to the IRS within six months of the end of each fiscal year (beginning with the first fiscal year that ends after the CPEO’s effective date of certification). For these purposes, a CPEO applicant’s or CPEO’s fiscal year will be considered completed once the last day of that fiscal year has ended, even if the CPEO was not operating or certified for the full fiscal year or the fiscal year was a short year consisting of fewer than 12 months.
Additionally, the Treasury Department and the IRS believe a CPEO with annual audited financial statements that reflect positive working capital (as determined in accordance with GAAP) presents a materially lower risk to the IRS’s collection of federal employment taxes than a CPEO without such financial statements. Accordingly, pursuant to section 7705(b)(1) and consistent with several state PEO certification and registration laws, the temporary regulations require a CPEO applicant or CPEO to cause to be prepared and provided to the IRS, by the same date it must provide a copy of its annual audited financial statements, an opinion of an independent CPA that such financial statements reflect positive working capital for the fiscal year, unless the exception described in the next paragraph applies. In addition, the temporary regulations require this opinion to set forth in detail a calculation of the CPEO applicant’s or CPEO’s working capital. Consistent with section 7705(c)(3)(A), this CPA opinion must also generally state that the financial statements are presented fairly in accordance with GAAP.
The Treasury Department and the IRS recognize that working capital may fluctuate over the course of a CPEO’s fiscal year due to normal business operations. To allow for some fluctuation in working capital, the temporary regulations contain an exception to the positive working capital requirement. Under this exception, a CPEO applicant or CPEO will not fail to meet the positive working capital requirement if three requirements are satisfied. First, the CPEO applicant or CPEO must have negative working capital for no more than two consecutive fiscal quarters of that fiscal year (as demonstrated by the financial statements for the final fiscal quarter of the fiscal year or the quarterly statements described in this section 3.c of the preamble for any other fiscal quarter). Second, the CPEO applicant or CPEO or its CPA must provide an explanation to the IRS describing the reason for the failure in such time and manner as the Commissioner may prescribe in further guidance. Third, the IRS must determine, in its sole discretion, that the failure does not present a material risk to the IRS’s collection of federal employment taxes.
The temporary regulations provide special rules for newly established CPEO applicants. A CPEO applicant that was not operating as a provider of employment-related services for all or part of the most recently completed fiscal year as of the date it applies for certification must also provide a copy of the audited financial statements of any precursor entity for the precursor entity’s most recently completed fiscal year as of the date of the application for certification, as well as a CPA opinion that these financial statements demonstrate positive working capital and are presented fairly in accordance with GAAP. The financial statements and CPA opinion for a precursor entity must be provided in such time and manner as the Commissioner may prescribe in further guidance.
In accordance with section 7705(c)(3)(A), the temporary regulations require the opinion regarding a CPEO’s financial statements to be provided by a CPA who is independent of the CPEO. For this purpose, the temporary regulations require a CPA to be independent as prescribed by the American Institute of Certified Public Accountants’ Professional Standards, Code of Professional Conduct, and its interpretations and rulings. The Treasury Department and the IRS request comments regarding whether the CPA independence guidelines or requirements of other governmental agencies or departments or industry self-regulatory bodies, as adapted for a CPA of a CPEO, would better ensure the impartiality of CPAs providing opinions on CPEO’s financial statements, such as:
(1) The Department of Labor’s guidelines on the independence of CPAs retained by employee benefit plans under 29 CFR 2509.75–9;
(2) the Securities and Exchange Commission’s (SEC) independence guidelines for auditors reporting on financial statements included in SEC filings; and
(3) the Government Accountability Office’s auditor independence requirements under Government Auditing Standards that cover federal entities and organizations receiving federal funds.
As previously noted, section 7705(b)(5) requires a CPEO to verify on a periodic basis that it meets certification requirements. In accordance with this requirement and pursuant to the Secretary’s general authority under section 7705(b)(1) to establish requirements for CPEOs to become and remain certified, the temporary regulations further require a responsible individual of the CPEO applicant or the CPEO to provide, by the last day of the second month after the end of each calendar quarter and beginning with the most recently completed quarter as of the date of the application for certification, a statement verifying under penalties of perjury that the CPEO applicant or the CPEO has positive working capital with respect to the most recently completed fiscal quarter. However, as with the requirement that annual financial statements reflect positive working capital, the temporary regulations also contain an exception to this requirement. The exception applies only if the CPEO does not have negative working capital at the end of the two fiscal quarters immediately preceding the fiscal quarter to which the statement relates. As with the exception provided with respect to annual financial statements that reflect negative working capital, the CPEO must also provide an explanation to the IRS describing the reason for the failure in such time and manner as the Commissioner may prescribe in further guidance, and the IRS must determine, in its sole discretion, that the failure does not present a material risk to the IRS’s collection of federal employment taxes.