Audit Costs of LIHTC Properties Could Soar Under New PCAOB Rules
By Caitlin Jones & A. J. Johnson
6 min read
Tax Credit Advisor March, 2006: Recently implemented federal audit guidelines for public companies could sharply increase the cost of auditing properties funded with Low Income Housing Tax Credits (LIHTCs).
The prospect of the increased expenses follows the Securities and Exchange Commission’s assent in January to guidance provided last year by the Public Company Accounting Oversight Board (PCAOB). Last May, PCAOB said that in cases like a mutual fund where a public company invests in other companies, each of the “lower tier” entities being invested in must also file audits under PCAOB’s tough new standards.
This has potentially dire consequences for the affordable housing industry, say market participants. It means that not only must all public tax credit funds be audited according to the new PCAOB standards, but that each of the operating partnerships providing tax credits to such a fund must also provide an audit under PCAOB standards as well.
LIHTC market participants had hoped that SEC would not insist on the separate lower-tier audits of tax credit properties.
“We don’t have an issue with complying at the upper tier, but I just don’t see how the lower-tier could comply – it would be a huge problem,” said David Gasson of the Housing Advisory Group, an industry alliance including syndicators, developers, accountants, and tax attorneys. Gasson is also a vice president at Boston Capital Corporation, a large tax-credit syndicator.
According to a memo sent to HAG members in late February, the lower-tier audits demanded by PCAOB could increase the average fees for an annual audit of an individual tax credit property from the current rate of about $7,000 under Generally Accepted Auditing Standards (GAAS) to between $8,500 and $9,500.
PCAOB is a private-sector, nonprofit created by the Sarbanes-Oxley Act of 2002, which was enacted in the wake of the Enron and WorldCom scandals to protect investors by improving the accuracy and reliability of corporate disclosures. PCAOB’s task is to oversee the auditors of public companies. It has recently established new auditing standards to achieve this purpose, and is in the process of implementing them. The SEC is charged with enforcing these standards.
Under the PCAOB auditing standards, public companies must follow procedures and provide documentation above and beyond GAAS. For example, unlike GAAS, the PCAOB standard requires that audits be prepared by an “independent” accountant – one not involved in the preparation of the company’s financial statements. PCAOB also requires each public company to prepare an internal control report that spells out how its audit is ensuring financial transparency.
A Widening Problem
Gasson pointed out that because the rents of tax credit properties are capped, their owners have a very limited ability to cover the additional expenses of preparing a PCAOB audit. In addition, he noted that because most tax-credit property audits are conducted by small accounting firms with limited staffs, the independent accountant requirement also poses a large problem.
Furthermore, if PCAOB and the SEC continue to insist on the lower-tier audits, Gasson said, “it is only a matter of time” before large accounting firms will also demand PCAOB audits from properties providing tax credits to non-public funds, the main vehicle nowadays for investment in LIHTCs.
This is so because the investors in the institutional tax-credit funds – which include commercial banks and government-sponsored enterprises such as Fannie Mae and Freddie Mac – are themselves public companies. Public tax-credit funds have steadily lost popularity with retail investors because the cost of administering them has reduced their yields to levels below competing investments. They now represent only a small portion of all tac credit funds.
A report issued by HAG noted that over 22,500 affordable housing properties have been built under the LIHTC program, all potentially requiring a yearly PCAOB lower-tier audit.
Pressing for Flexibility
Gasson said that the affordable housing industry is just now beginning to become aware of the potentially huge expenses of lower-tier PCAOB audits, and to press for regulatory flexibility.
“People didn’t really worry about the problem until recently because this isn’t a direct assault on LIHTC, but an indirect cost,” he said. The long ramp-up time that PCAOB has taken to establish its audit guidelines has also contributed to the problem, creating a sense that the problem would be resolved before it became a crisis.
Tax-credit funds must now catch up on handling lower-tier audits of 2004 financials originally due in 2005 – but deferred because of the lack of clarity about the PCAOB’s rules – as well as begin to prepare for audits of 2005 lower-tier financials due this year, he said.
Industry representatives began to meet last year with both the PCAOB and the SEC to argue for flexibility, Gasson said. Although PCAOB and the SEC have acknowledged that the lower-tier audits will cause problems, “they felt it would set a dangerous precedent to grant relief to the LIHTC industry” by making an exception for tax-credit properties, he added.
However, the SEC has indicated it will grant one area of flexibility: waiving the requirement, through December 31, 2005, that lower-tier audits of tax-credit properties be conducted by an independent auditor. “This would be a good step,” said Gasson.
Kurtis Wolff, National Director of Audit and Accounting at the Reznick Group, said he hoped it is not too late for further flexibility from PCAOB and the SEC, and praised both organizations for “devoting a large amount of time to considering the issues involved for the affordable housing industry.” He said that one possible solution would be for a tax-credit fund’s auditing firm to take under its opinion the “lower tier” audits.
But this solution – even it is permitted by PCAOB and the SEC – would raise difficult issues about who would bear the additional cost, Wolff said. HAG estimates that such an approach would cost a minimum of $500 per lower-tier audit.
Developing a Strategy
Gasson said that HAG is pressing the issue of the lower-tier audits beyond the PCAOB and SEC and has begun discussions with the members and staff of the congressional committees that wrote the Sarbanes-Oxley Act. Those committees are the House Financial Services Committee, which is chaired by Rep. Michael Oxley (R-Ohio), and the Senate Banking Committee, chaired by Sen. Richard Shelby (R-Ala.). A technical corrections bill amending the Sarbanes-Oxley Act would be another possible solution.
Richard Bellas, a lawyer with the Washington D.C.-based Davis & Harman LLP, who serves as counsel to the HAG, argued that application of the PCAOB standards to lower-tier tax-credit properties is unjustified because there is already very adequate regulatory oversight. This is provided, first, by the state housing finance agencies, which award LIHTCs and monitor their use. In addition, the Internal Revenue Service makes sure that housing tax credits comply with the federal tax code.
“This regulatory regimen provides excellent protection to investors,” Bellas said.
