hidden tax strategies for savvy business...
TRANSCRIPT
Hidden Tax Strategies For Savvy Business Owners June 28, 2016 The webinar will begin at 1:30 p.m. CT
Bruce Stubbs, JD, LLM Vice President AGH Specialized Tax Solutions
Adam Manlove Manager, Tax Services
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About the Speaker
Bruce Stubbs, JD, LLM Vice President AGH Specialized Tax Solutions 20 years legal/tax consulting experience Specialized knowledge in R&D tax credit, cost segregation, and repair regulations
About the Speaker
Adam Manlove Manager, Tax Services Handles business tax planning and compliance Member of AICPA, KSCPA and YPW
Learning Objectives
Identify the business circumstances that can allow the implementation of new tax strategies.
Learn how R&D tax credit, cost segregation, and IC-DISC can benefit your business.
Understand updates to the PATH Act for bonus depreciation and Section 179 expensing.
R&D TAX CREDIT
Federal Credit Benefit
Benefit averages $0.065 per dollar spent on Qualified Research Expenses (QREs).
IRC §38 - General business credit
IRC §39 - 1-year carryback, 20-year carryforward
Dollar-for-dollar reduction in tax Subject to AMT limitations
• Eligible small business (ESB) exception starting in 2016
PATH Act of 2015
PERMANENT
Retroactive to amounts paid or incurred after 12/31/2014
No changes to credit percentage rates or methods
2 additional options for some to utilize the credit: Offset against AMT Offset against payroll tax
PATH Act of 2015 (Cont.)
Ability to offset Alternative Minimum Tax (AMT) allowed Applies to: Tax years beginning after Dec. 31, 2015
Limited to: “Eligible small businesses” (ESB) – defined as:
i. Corporation - the stock of which is not publically traded,
ii. Partnership, or iii. Sole proprietorship, and iv. Prior 3-year avg. annual gross receipts do not
exceed $50 million
PATH Act of 2015 (Cont.)
Ability to utilize the credit to offset payroll taxes Applies to: Startup companies Tax years beginning after Dec. 31, 2015
Limited to: “Qualified small businesses” (QSB) – defined as:
i. Corporation, partnership, or individual, ii. Gross receipts < $5 million, and iii. No gross receipts for any tax year preceding the
5th tax year period ending with the current tax year
PATH Act of 2015 (Cont.)
Payroll tax credit is equal to the least of: 1) Amount specified by the taxpayer < $250,000, 2) Research credit determined for the tax year, or 3) If a QSB other than a partnership or S corp., the
amount of the business credit carryforward under §39 from the tax year.
Credit Qualification Myths
Must “discover” something beyond what’s known in the industry False – “Discovery Test” is no longer the standard.
Only performing “white lab coat” type activities in a high-tech or bio-tech company qualifies.
False – Anyone who satisfies the 4-Part Test can qualify.
Must be successful and product must be available for sale False – Neither are required to qualify for the credit.
Government contractors don’t qualify. False – Anyone who satisfies the 4-Part Test can potentially
qualify. o Need to be “at risk” and “retain rights” o Contract terms are key.
Applicable Industries
Applies to all industries, including: Aircraft Agriculture Apparel Automotive Chemical Computer software Cosmetics Defense contractors Electronics
Engineering Equipment & machinery Food & beverage Manufacturing Medical Oil & gas Pharmaceutical Telecommunications Tooling, molds & dies
Study Examples
Packaging films – 3D and holographic Bee Shotgun – Developed a ‘gun’ to launch a shell filled with non-lethal smoke to disperse bees on power poles Pet products – Puppy pads, soaps, odor removers (chemical formulas) Formulas – Food & beverage service providers, flavor formulations, new & replacement ingredient selection, organic and natural foods Electric fans – Residential and industrial - motors, blade & case designs Defense contractor – Switch components & wiring harnesses for weapons Original equipment manufacturers (OEMs):
Cable assemblies & throttle controls – Motorcycles and riding lawn mowers
Plastic tubing – Medical devices & equipment
R&D 4-Part Test
• Must be present at beginning of project • Uncertainty concerns: capability, methodology, or
appropriateness of design
Test # 1 Elimination of
Uncertainty
• Physical or biological sciences, computer science or
engineering
Test # 2 Technological in
Nature
• New or improved business component as to: function, performance, reliability or quality
• Not qualified if relates to: style, taste, cosmetic or seasonal design factors
Test # 3 Permitted Purpose
• Evaluate 1 or more alternatives to resolve uncertainty. • Substantially all activities (> 80%) constitute elements of a
process of experimentation.
Test # 4 Process of
Experimentation
Qualified Activities
Idea Generation
Product Design
Prototype Build & Testing
Final Approval
Idea Generation: • Concept
design • Technical /
performance specifications identified
• Technical team meetings
Prototype Design: • 3D modeling • Technical design
meetings • Production
capability assessment
• New tooling design & development
Prototypes: • CAD analysis • Product mock-up • Destructive or non-
destructive testing • QA testing • Life cycle testing • Field testing
Final Approvals: • Design • Performance specs • Safety review • Certifications
Polling Question #1
IC-DISC
IC-DISC = Interest Charge Domestic International Sales Corporation
IC-DISC: What Is It?
IC-DISC is an IRS-approved tax strategy that can provide cash to exporters and their owners through tax savings.
“The last remaining export incentive…” Ryan L. Losi
Key Elements
Open to domestic exporters who meet criteria
Relatively easy to create/administer
“Paper corporation”
Tax exempt
Dividends qualify for reduced tax rate.
Foreign Trading Gross Receipts (FTGR)
Qualified export receipts that include:
Export property
Supporting services
Interest on qualified export assets
Non-US engineering/ architectural services
Export Property
US grown, produced or manufactured Mainly for sale outside US More than 50% of FMV attributed to US content
Qualified Export Assets
At least 95% of DISC assets at year-end must be qualified export assets: Trade Receivables Temporary Investments Producer Loans
Potential Tax Savings
Producer/exporter pays commission
to IC-DISC
IC-DISC pays dividend to
shareholders Permanent tax
savings
Typical Structure – S Corporation/Partnership
Commission
Dividend U.S. Exporter IC-DISC
Owner(s)
Typical Structure – C Corporation
Commission
Tax Savings
Dividend
U.S. Exporter IC-DISC
Owner(s)
Tax Savings Example
Foreign trading gross receipts $4,000,000 Cost of goods sold 2,500,000 Gross margin $1,500,000 Allocable operating/G&A expenses $500,000 Export sales net income $1,000,000 IC-DISC commission is greater of: 50% of export net income $500,000 4% of export receipts $160,000
Tax Savings Example (Cont.)
IC-DISC commission $500,000 Federal tax savings at 39.6% $198,000 IC-DISC dividend distribution $500,000 Federal tax cost at 23.8% (119,000) Net tax savings $79,000
Tax Deferral/Producer Loan
IC-DISC commission functions like a loan.
Producer deducts interest paid to DISC.
Tax deferral “cap”
Shareholder pays “interest charge” to IRS.
Maintenance Steps
I. Maintain separate books & records.
II. Timely commission calculation & maximization
III. Timely fund movement
IV. Producer loan documentation, if applicable
V. Tax preparation
Costs
One-time implementation costs: $6,000 - $10,000
Annual maintenance costs:
$4,000 - $8,000
*IMPORTANT – Benefits only for shipments after formation
Polling Question #2
COST SEGREGATION
Cost Segregation Defined
Formal engineering process accepted by the IRS
Identifies building costs and land improvement costs traditionally depreciated over 39 years for Nonresidential Real Property or 27.5 years for Residential Rental Property
Re-allocates a significant amount of the “building” costs to asset classes with shorter depreciation lives (accelerated depreciation)
Qualifying costs are assigned to 5, 7, and 15 year lives
Results in: Accelerated depreciation deductions Reduced tax liability Increase in cash flow
Benefits of Cost Segregation
Increase cash flow with accelerated deductions.
Benefits of Cost Segregation (Cont.)
Cost segregation studies accelerate deductions.
Studies do not increase overall depreciation deductions.
Total capitalized costs for a building & land improvements will fully depreciate with or without a study performed.
Benefit: Time Value of Money “A dollar today is worth more than a dollar tomorrow.”
When to Perform a Study
Most properties will benefit: • New construction • Acquisitions • Existing properties – “Look-back” and “catch-up” • Leasehold improvements • Renovations • Green / LEED projects Study is not recommended if: Owner plans on selling the property within the first 3-5 years of ownership because of depreciation recapture.
Property Reclass Percentages
Property Type Typical Reclass %’s Assisted Living / Ambulatory Facility 15 - 25%
Apartment / Multi-Family Building 15 - 30% Automobile Dealership 20 - 35%
Bank Buildings 25 - 35% Computer Data Center / Technology Center 20 - 45%
Distribution 5 - 15% Fitness Center / Health Club 20 - 45%
Golf Course 20 - 40% Grocery Stores 20 - 30%
Healthcare / (Medical / Dentist / Diagnostic) 30 - 40% Hospitality / Hotels 20 - 35%
Industrial / Manufacturing 30 - 45% Office Building 15 - 30% Printing Facility 15 - 35%
Research and Development 20 - 50% Restaurants (Single or Multiple) 20 - 38%
Retail (Department / Specialty Store) 20 - 30% Self Storage Facility 20 - 45%
Shopping Center 15 - 30% Theater 20 - 35%
Warehouse 10 - 15%
Example: Hotel
Type: New Construction – Current Year Study Cost: $4,505,035
Placed in Service: 2014 % Reclassified: 30.5%
1st Year Additional Depreciation $797,530
1st 5 Years Additional Depreciation $1,128,571
1st Year Tax Savings Benefit $315,822
1st Five Years NPV Tax Savings Benefit $437,760
Overall NPV Tax Savings (Net Present Value)
$243,002
Example: Apartment Complex
Type: Acquisition – Current Year Study Year Acquired: 2013
# of units: 10 Buildings / 132 Units Purchase Price: $5,476,000 % Reclassified: 24.64%
1st Year Additional Depreciation $754,765
1st 5 Years Additional Depreciation $1,001,894
1st Year Tax Savings Benefit $298,132
1st Five Years NPV Tax Savings Benefit $384,202
Overall NPV Tax Savings (Net Present Value)
$292,220
Example: Car Dealership
Type: Renovation / Remodel of Showroom – Current Year Study Cost: $2,237,000 Placed in Service: 2013 Study Performed: 2013 % Reclassified: 23.8%
1st Year Additional Depreciation $311,472
1st 5 Years Additional
Depreciation $447,208
1st Year NPV Tax Savings Benefit $123,031 1st Five Years NPV Tax Savings Benefit $170,414
Overall NPV Tax Savings (Net Present Value)
$123,787
Increased importance
8 building systems specifically identified by new Repair Regs.: 1. HVAC systems 2. Plumbing systems 3. Electrical systems 4. All escalators 5. All elevators 6. Fire protection and alarm systems 7. Security systems 8. Gas distribution system 9. Other structural components identified in published
guidance in the Federal Register or in the Internal Revenue Bulletin
FINAL TANGIBLE ASSET REPAIR & DISPOSITION REGULATIONS
Effective dates
Final regulations are generally effective for taxable years beginning on or after Jan. 1, 2014. These regulations are mandatory and not elective! Apply to amounts paid or incurred in taxable years
beginning on or after Jan. 1, 2014 for: • Materials and supplies • De minimis safe harbor election • Certain facilitative costs • Safe harbor for small taxpayers • Election to capitalize repair and maintenance
costs 49
General Framework
Materials and supplies
Reg. §1.162-3
Capital expenditures
in general Reg.
§1.263(a)-1
Costs to acquire or produce tangible property
Reg. §1.263(a)-2
Costs to improve tangible property
Reg. §1.263(a)-3
Dispositions/ General asset
accounts Reg.
§1.168(i)-1, 7, and 8
“BAR” Test
Opportunity for retirement loss or disposition deductions
“BAR” Test – Reg. §1.263(a)-3
Improvement = Capitalize
Betterment
Adaptation
Restoration
OPPORTUNITY TO CLAIM RETIREMENT LOSS OR DISPOSITION DEDUCTIONS
Tangible Asset Repair Regulations
Case Study Example #1
53
Automobile Dealership Remodel Remodel Cost $2,550,000 Cost Segregation Study on Remodel:
Additional 1st Yr. Deductions - $568,579 Additional 1st Yr. Tax Savings - $224,589 Overall Net Present Value Savings - $224,348
Fixed Asset Study: Retirement Loss Deductions - $612,249 Removal Cost Deductions - $81,367 Total Additional Deductions - $693,616 Estimated Tax Savings - $274,672
Total Savings = $499,020
Appendix
54
Final Regulations Examples Betterment - Reg. §1.263(a)-3(j) Adaptation – Reg. §1.263(a)-3(l)(3) Restoration – Reg. §1.263(a)-3(k)(7)
Betterment Examples
Betterment Examples - Regulation §1.263(a)-3(j)(3) Betterment?
#1
Amelioration of pre-existing condition or defect. Remediation of soil contamination - unaware at time of purchase Yes
#2
Not amelioration of pre-existing condition or defect. Removal and replacement of asbestos insulation with new insulation that is no more efficient or effective than the asbestos insulation
No
#3 Regularly scheduled maintenance shortly after purchase No
#4 Minor repairs shortly after purchase No
#5 Bringing assisted living facility up to higher standards after purchase Yes
#6 Building refresh look & layout No
In the course of the building refresh replacing and reconfiguring display tables & racks Yes #7 Building refresh similar to example #6 No
At same time increase storage space, add loading dock and second overhead door Yes
#8 Substantial remodel of stores Yes
#9 Relocation and reinstallation of cash registers No
#10
Relocating and reinstallation of equipment with additional components that increase capacity Yes
#11 Meeting newly imposed earthquake resistance standards Yes
#12 Add concrete lining to walls of meat processing plant to correct seepage No
Betterment Examples (Cont.)
Betterment Examples - Regulation §1.263(a)-3(j)(3) (cont’d)
Betterment? #13 New roof membrane No
#14 Reinforce columns and girders increasing load-carrying capacity of 2nd floor storage
Yes
#15 Doubling the depth of a channel at harbor facilities from 10 ft. to 20 ft. Yes
#16 Redredging channel subject to siltation (from 18 ft. to 20 ft.) No
#17 Redredging and increasing channel from 18 ft. to 25 ft. - increased capacity 25%
Yes
#18 Remove drop-ceiling and repaint original ceiling No
#19 Add stairway and mezzanine to add additional selling space to building Yes
#20 Replacement of 2 of 10 HVAC units that are 10% more efficient No
#21 Adding insulation making building 50% more energy efficient Yes
#22 Add drive through service area to a restaurant Yes
#23 Costs incurred during betterment to patch holes and repaint walls Yes
Adaptation Examples
57
Adaptation Examples - Regulation §1.263(a)-3(l)(3)
Adaptation? #1 Convert manufacturing facility into showroom Yes #2 Remove walls to combine 3 leased retail spaces into 1 No #3 Repaint walls and refinish floors in anticipation of selling No
#4 Remediate contamination after closing manufacturing plant No Regrade land for residential development Yes
#5 Reconfigure retail pharmacy to add walk-in medical clinic Yes #6 Convert part of retail grocery store to a sushi bar Yes
#7 Convert portion of hospital emergency room to outpatient surgery center
Yes
Restoration Examples
58
Restoration Examples - Regulation §1.263(a)-3(k)(7) Restoration?
#1 Replace walk-in freezer components disposed of through abandonment and loss recorded
Yes
#2 Replace walk-in freezer components disposed of through sale and loss recorded Yes
#3 Restoration after casualty loss deduction Yes
#4 Restoration after casualty basis adjustment for insurance proceeds Yes
#5 Casualty repair in excess of casualty loss No
#6 Restoration of property allowed to fall into state of disrepair Yes
#7 Rebuild of property to like-new condition before end of class life - freight cars No
#8 Rebuild of property to like-new condition after end of life - freight cars Yes
#9 Heavy maintenance - aircraft - after end of class life but not to like-new condition No
#10 Replacement of major component / substantial structural part Yes
#11 Repair performed during restoration Yes
#12 Removal costs - no loss taken on disposition of old USTs Yes
#13 Replace power switch assembly on drill press No
#14 Replace entire roof Yes
#15 Replace roof membrane No
Restoration Examples
59
Restoration Examples - Regulation §1.263(a)-3(k)(7) Restoration?
#16 Replace 1 of 3 furnaces in HVAC system No
#17 Replace the only chiller in an HVAC system Yes
#18 Replace 3 of 10 roof-mounted HVAC systems No
#19 Replace sprinkler system Yes
#20 Replace entire electrical system Yes
#21 Replace 30% of electrical system No
#22 Replace all toilets and sinks Yes
#23 Replace 8 of 20 sinks No
#24 3-year plan to remodel hotel including repairing, repainting & retiling walls Yes
#25 Replace 100 of 300 exterior windows comprising 8.3% surface area of building No
#26 Replace 200 of 300 exterior windows comprising 16.67% surface area of building Yes
#27 Replace 100 of 300 exterior windows comprising 30% of surface area of building Yes
#28 Replace lobby floors comprising < 10% sq. footage of entire building No
#29 Replace floors in all public areas comprising 40% of total building square footage Yes
#30 Replace 1 of 4 elevators No
#31 Replace 1 of 4 elevators and claim partial disposition loss Yes
Polling Question #3
PATH ACT
PATH Act: Changes to Sec. 179 Expensing
Prior Law $500,000 maximum expense
Was set to drop to $25,000 for 2015 $2,000,000 investment phase-out
Was set to drop to $200,000 for 2015 Qualified Real Property
$250,000 maximum expense No carryover to 2015 tax years
PATH Act: Changes to Sec. 179 Expensing
PATH Act Changes $500,000 maximum expense and $2,000,000 investment phase-out
Retroactively extended and made permanent Adjusted for inflation ($500,000 / $2,010,000 for 2016)
Permanently extended expensing of Qualified Real Property
Removed $250,000 expensing limitation starting 2016 Removed air conditioning and heating units from list of ineligible property
PATH Act: Changes to Bonus Depreciation
Prior Law 50% bonus depreciation set to expire 12/31/14 Real property eligible for bonus depreciation
Must meet definition of Qualified Leasehold Improvement Property
PATH Act: Changes to Bonus Depreciation
PATH Act Changes Bonus depreciation extended
50%: 2015-2017 40%: 2018 30%: 2019
Real property eligible for bonus depreciation 2015 – no change Beginning 2016 – Must meet definition of Qualified Improvement Property
PATH Act: Changes to Bonus Depreciation
Qualified Improvement Property Improvement to interior portion of a building Placed in service after date building was first placed in service Excludes improvements for:
Enlargement of building Elevator or escalator Internal structural framework
PATH Act: Changes to Bonus Depreciation
Qualified Improvement Property – Changes from prior law
Property does not have to be subject to a lease Need not be placed in service more than 3 years after building placed in service Structural components benefiting a common area are no longer excluded. Potential to take bonus depreciation on 39-year property
PATH Act:15-year Property
Prior Law 15-year recovery period for qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property set to expire at 12/31/14
PATH Act Changes Retroactively extended and made permanent the 15-year recovery period Defined the same as prior law
Polling Question #4
Thank you!
Bruce Stubbs, JD, LLM Vice President AGH Specialized Tax Solutions [email protected] linkedin.com/in/brucestubbs 316.291.4149
Adam Manlove Manager, Tax Services [email protected] linkedin.com/in/adammanlove1 316.291.4074
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