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R&D Tax Credits Cost Segregation Fixed Asset Review Repair v. Capitalization • State & Local Tax Services www.aghsts.com Toll-Free 844.787.2121
Presented by: Bruce L. Stubbs, J.D., LL.M. Vice President AGH Specialized Tax Solutions
R&D Tax Credits Cost Segregation Fixed Asset Reviews Repair v. Capitalization •Sales & Use Tax Services www.aghsts.com • Toll-Free 844.787.2121
Learning Objectives
Impact of Protecting Americans from Tax Hikes (PATH) Act of 2015 Discuss overview of Federal & State benefits Learn how to identify qualified vs. non-qualified activities Differentiate the calculation method options and discuss examples Hear updates on case law, and IRS regulations & proposals
I.
II.
III.
IV.
V.
R&D Tax Credits Cost Segregation Fixed Asset Reviews Repair v. Capitalization •Sales & Use Tax Services www.aghsts.com • Toll-Free 844.787.2121
I. Protecting Americans from
Tax Hikes (PATH) Act of 2015
R&D Tax Credits Cost Segregation Fixed Asset Reviews Repair v. Capitalization •Sales & Use Tax Services www.aghsts.com • Toll-Free 844.787.2121
PATH Act of 2015
• PERMANENT
• Retroactive to amounts paid or incurred after 12/31/2014
• Both calculation methods retained
• No changes to credit percentage rates
• 2 additional options for some to utilize the credit:– Offset against AMT– Offset against payroll tax
R&D Tax Credits Cost Segregation Fixed Asset Reviews Repair v. Capitalization •Sales & Use Tax Services www.aghsts.com • Toll-Free 844.787.2121
PATH Act of 2015
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, oriii. Sole proprietorship, andiv. Prior 3-year avg. annual gross receipts do not exceed $50 million
R&D Tax Credits Cost Segregation Fixed Asset Reviews Repair v. Capitalization •Sales & Use Tax Services www.aghsts.com • Toll-Free 844.787.2121
PATH Act of 2015
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 for the taxable year, andiii. No gross receipts for any tax year preceding the 5-tax-year
period ending with the current tax year
R&D Tax Credits Cost Segregation Fixed Asset Reviews Repair v. Capitalization •Sales & Use Tax Services www.aghsts.com • Toll-Free 844.787.2121
PATH Act of 2015
Payroll tax credit amount 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 thebusiness credit carryforward under §39 from the tax year.
R&D Tax Credits Cost Segregation Fixed Asset Reviews Repair v. Capitalization •Sales & Use Tax Services www.aghsts.com • Toll-Free 844.787.2121
PATH Act of 2015
Payroll tax credit limitations:
1. Can’t make election if made for 5 or more preceding tax years
2. Partnership or S Corp - election made at entity level
3. Payroll tax credit portion allowed against employer OASDI (socialsecurity portion) of FICA in 1st quarter after date on whichcompany files its income tax or information return.
4. Can’t exceed OASDI each quarter, carryforward to next quarter.
5. Can’t be taken against hospital insurance liability (HI) of FICA taxes.
6. Can’t be taken against the employee OASDI liability required to bewithheld.
R&D Tax Credits Cost Segregation Fixed Asset Reviews Repair v. Capitalization •Sales & Use Tax Services www.aghsts.com • Toll-Free 844.787.2121
• Dollar-for-dollar reduction in tax Subject to AMT limitations o Eligible small business (ESB) exception
R&D Tax Credits Cost Segregation Fixed Asset Reviews Repair v. Capitalization •Sales & Use Tax Services www.aghsts.com • Toll-Free 844.787.2121
States Offering R&D Credits
• Arizona • Indiana • Nebraska • Texas
• Arkansas • Iowa • New Hampshire • Utah
• California • Kansas • New Jersey • Vermont
• Colorado • Kentucky • New York • Virginia
• Connecticut • Louisiana • North Carolina • West Virginia
• Delaware • Maine • North Dakota • Wisconsin
• Florida • Maryland • Ohio
• Georgia • Massachusetts • Oregon
• Hawaii • Michigan • Pennsylvania
• Idaho • Minnesota • Rhode Island
• Illinois • Mississippi • South Carolina
R&D Tax Credits Cost Segregation Fixed Asset Reviews Repair v. Capitalization •Sales & Use Tax Services www.aghsts.com • Toll-Free 844.787.2121
States Without R&D Credits
• Alabama* • Oklahoma*
• Alaska • South Dakota
• Missouri • Tennessee
• Montana • Washington
• Nevada • Washington DC
• New Mexico • Wyoming
R&D Tax Credits Cost Segregation Fixed Asset Reviews Repair v. Capitalization •Sales & Use Tax Services www.aghsts.com • Toll-Free 844.787.2121
State Credit Benefits
• Nonrefundable vs. refundable
• Application process
• Nontransferable
• Options on utilization
R&D Tax Credits Cost Segregation Fixed Asset Reviews Repair v. Capitalization •Sales & Use Tax Services www.aghsts.com • Toll-Free 844.787.2121
POLLING QUESTION #1
R&D Tax Credits Cost Segregation Fixed Asset Reviews Repair v. Capitalization •Sales & Use Tax Services www.aghsts.com • Toll-Free 844.787.2121
III. Credit Qualifications - Facts vs. Myths
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Myths as to Credit Qualification
• 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
R&D Tax Credits Cost Segregation Fixed Asset Reviews Repair v. Capitalization •Sales & Use Tax Services www.aghsts.com • Toll-Free 844.787.2121
• Original equipment manufacturers (OEMs): Cable assemblies & throttle controls – Motorcycles and riding lawn
mowers Plastic tubing – Medical devices & equipment
R&D Tax Credits Cost Segregation Fixed Asset Reviews Repair v. Capitalization •Sales & Use Tax Services www.aghsts.com • Toll-Free 844.787.2121
IV. R&D 4-Part Test and
Qualified Activities & Expenses
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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
R&D Tax Credits Cost Segregation Fixed Asset Reviews Repair v. Capitalization •Sales & Use Tax Services www.aghsts.com • Toll-Free 844.787.2121
Internal Use Software
• The software must be technologically innovative in a unique or novel way from prior implementations or methods (substantial improvements in speed or capabilities).
Test # 5 Innovation
• Substantial resources committed to project, and uncertainty such funds will be recovered in a reasonable period of time because of technical uncertainties.
Test # 6 Significant Economic
Risk
• Software that satisfies taxpayer’s requirements without substantial modification is not available for purchase, lease or license.
Test # 7 Not Commercially
Available
3 Additional Tests (“high threshold of innovation”):
R&D Tax Credits Cost Segregation Fixed Asset Reviews Repair v. Capitalization •Sales & Use Tax Services www.aghsts.com • Toll-Free 844.787.2121
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Non-Qualified Activities
Per §41(d)(4): • Activities performed outside the United States, Commonwealth of
Puerto Rico, or any US possession • Adaptation or duplication of an existing business component • Social sciences – “Soft” sciences, arts, or humanities • Surveys or studies related to efficiencies; management function,
technique or profitability; market research, testing or development (including advertising & promotions); style, taste, cosmetic or seasonal design factors
• Routine data collection and ordinary QA testing • Funded research – Anything funded by any grant, contract or
otherwise by any person or governmental entity Taxpayer must bear both the economic risk & retain rights in the
results.
R&D Tax Credits Cost Segregation Fixed Asset Reviews Repair v. Capitalization •Sales & Use Tax Services www.aghsts.com • Toll-Free 844.787.2121
Non-Qualified Activities
Per §41(d)(4)(A): Research after commercial production
Per Reg. §1.41-4(c)(2)(ii) - the following are deemed to occur after commercial production:
• Preproduction planning for a finished business component • Tooling up for production • Trial production runs • Troubleshooting detecting faults in production equipment
or processes • Accumulating data relating to production processes • Debugging flaws in a business component
R&D Tax Credits Cost Segregation Fixed Asset Reviews Repair v. Capitalization •Sales & Use Tax Services www.aghsts.com • Toll-Free 844.787.2121
Qualified Research Expenses IRC §174 – Research & Experimental
Expenditures “…incurred in connection with the
taxpayer’s trade or business…”
“in the experimental or laboratory sense”
to eliminate uncertainty concerning new or
improved products or processes
IRC §41 R&D credit limits qualified expenses to 3 buckets:
R&D Tax Credits Cost Segregation Fixed Asset Reviews Repair v. Capitalization •Sales & Use Tax Services www.aghsts.com • Toll-Free 844.787.2121
Qualified Research Expenses
1. W-2, Box 1 income - as defined under §3401 subject to withholding (includes taxable benefits, bonuses, etc.) Excludes: 401k & pre-tax benefits; and wages used for Work Opportunity Credit 2) Partnership earnings subject
to SE tax 3) Schedule C income
(Self-employed individuals)
Wages
Tangible property used or consumed in qualified research activities (e.g., prototypes) Excludes: a) Land – acquisition &
improvements b) Depreciable property
Supplies Contract Research
1) 65% of amounts paid to non-employees
2) 75% paid to certain qualified research consortia
3) 100% of amounts paid for energy research to eligible small businesses, universities, and Federal laboratories
R&D Tax Credits Cost Segregation Fixed Asset Reviews Repair v. Capitalization •Sales & Use Tax Services www.aghsts.com • Toll-Free 844.787.2121
POLLING QUESTION #2
R&D Tax Credits Cost Segregation Fixed Asset Reviews Repair v. Capitalization •Sales & Use Tax Services www.aghsts.com • Toll-Free 844.787.2121
V. Calculation Methods & Examples
R&D Tax Credits Cost Segregation Fixed Asset Reviews Repair v. Capitalization •Sales & Use Tax Services www.aghsts.com • Toll-Free 844.787.2121
2 Annual Considerations
Two key considerations each year: 1. Which credit method to use 2. Whether to make the §280C Reduced Credit Election
§280C Reduced Credit Election:
• Annual election • 35% reduction to current year’s calculated credit amount • Avoids reduction to current year QREs deducted by amount of the
credit • No “double benefit” • Generally will make the §280C election if subject to tax • Preserves election if taxpayer amends return to claim R&D credit
R&D Tax Credits Cost Segregation Fixed Asset Reviews Repair v. Capitalization •Sales & Use Tax Services www.aghsts.com • Toll-Free 844.787.2121
Calculation Methods
Two calculation methods currently available:
1. Regular Credit - §41(a)(1) • “Old & Cold” method • Base Period (1984 – 1988) or Start-up (1994 – forward)
2. Alternative Simplified Credit (ASC) - §41(c)(5) • Available for tax years ending after Dec. 31, 2006 • Fewer years involved - current year & prior 3 years
R&D Tax Credits Cost Segregation Fixed Asset Reviews Repair v. Capitalization •Sales & Use Tax Services www.aghsts.com • Toll-Free 844.787.2121
Regular Credit Method
• IRC §41(a)(1)
• Credit = 20% x Current Year QREs over Base Amount
• 4 items necessary to calculate the Regular Credit: Step 1 - Qualified Research Expenses (QREs) Step 2 - Prior 4 Years Average Annual Gross Receipts Step 3 - Fixed-Base % Step 4 - Base Amount
R&D Tax Credits Cost Segregation Fixed Asset Reviews Repair v. Capitalization •Sales & Use Tax Services www.aghsts.com • Toll-Free 844.787.2121
Step 2 – Prior 4 Years Avg. Gross Receipts
• Reg. §1.41-3(c): Gross Receipts is a broad definition & includes “… the total amount … derived by the taxpayer from all its activities…” including:
⁃ Net sales ⁃ Rental income ⁃ Interest income ⁃ Royalty income ⁃ Dividend income ⁃ Other income
• Six exclusions – Reg. §1.41-3(c)(2)(i) – (vi): Returns or allowances Receipts from the sale or exchange of capital assets (§1221) Repayment of loans or similar instruments Receipts from sale or exchange not in the ordinary course of
business Amounts received as sales & other taxes merely collected & remitted De minimis rule of active gross receipts less than $25,000
R&D Tax Credits Cost Segregation Fixed Asset Reviews Repair v. Capitalization •Sales & Use Tax Services www.aghsts.com • Toll-Free 844.787.2121
Step 3 - Fixed-Base %
Method depends on when the company was organized & 1st performed R&D
Either: (1) Base Period Fixed-Base % If have both Qualified Research Expenses & Gross Receipts prior to 1984 and in 3 out of 5 years during 1984 – 1988, then: Fixed-Base % = 1984-1988 QREs / 1984-1988 GRs
(2) Start-up Fixed-Base % If 1st taxable year beginning after Dec. 31, 1993, when taxpayer has both Qualified Research Expenses & Gross Receipts, then: Fixed-Base % is:
• 3% fixed for 1st 5 tax years • Fluctuates over next 5 tax years based on formulas • Becomes fixed in year 11 – unless acquisitions or dispositions occur
Maximum Fixed-Base % = 16%
R&D Tax Credits Cost Segregation Fixed Asset Reviews Repair v. Capitalization •Sales & Use Tax Services www.aghsts.com • Toll-Free 844.787.2121
Step 4 - Base Amount
• Base Amount limits the amount of Qualified Research Expenses available for the current year credit calculation.
• Regular Credit Base Amount is always the greater of: Fixed-Base % x 4 Prior Year Average Annual Gross Receipts; or
• Documentation 4-Part Test – uncertainties, process of experimentation Track at business component level Nexus for tracking costs Time tracking system Sufficient software capability to capture necessary information
R&D Tax Credits Cost Segregation Fixed Asset Reviews Repair v. Capitalization •Sales & Use Tax Services www.aghsts.com • Toll-Free 844.787.2121
Preserve §280C Reduced Credit Election
Check yes on line 17 √
R&D Tax Credits Cost Segregation Fixed Asset Reviews Repair v. Capitalization •Sales & Use Tax Services www.aghsts.com • Toll-Free 844.787.2121
POLLING QUESTION #3
R&D Tax Credits Cost Segregation Fixed Asset Reviews Repair v. Capitalization •Sales & Use Tax Services www.aghsts.com • Toll-Free 844.787.2121
VI. IRS Updates and Case Law
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IRS Updates
Internal Use Software (IUS)
Jan. 16, 2015 – Prop. Reg. (REG-153653-03) released
1. Distinguishes IUS from non-IUS
2. IUS is ‘general and administrative functions’ – limited to: a. Financial management functions b. Human resource management functions c. Support services functions (day-to-day type activities)
3. Non-IUS a. Held for commercial sale, lease, or license; or b. Third-party-facing - interacts with 3rd parties, or allows 3rd parties
to initiate functions or review data on taxpayer’s system
R&D Tax Credits Cost Segregation Fixed Asset Reviews Repair v. Capitalization •Sales & Use Tax Services www.aghsts.com • Toll-Free 844.787.2121
IRS Updates
Internal Use Software (IUS)
4. High threshold of innovation tests still apply to IUS a. Prong 1 – Innovation
i. Reduction in cost or improvement of speed or other measurable improvement that is substantial and economically significant
b. Prong 2 – Significant economic risk i. Application at the level of ‘substantial uncertainty’ present at the
beginning, not the degree of innovation achieved ii. ‘Substantial uncertainty’ exists if available information doesn’t
establish the ‘capability or method’, not to the appropriate design iii. Both technical and economic risk must be present
c. Prong 3 – Not commercially available for use without modification – which satisfies Prongs 1 and 2
R&D Tax Credits Cost Segregation Fixed Asset Reviews Repair v. Capitalization •Sales & Use Tax Services www.aghsts.com • Toll-Free 844.787.2121
IRS Updates
Internal Use Software (IUS)
5. Dual-function software – both internal and non-internal use a) Rules presume – designed “primarily” for internal use
b) No presumption if a subset is identified & only serves as third-party-functional interaction (TPFI) – only 4-Part Test applies
c) Safe harbor available if unable to isolate one or more subsets
1. If reasonably anticipated at least 10% will constitute TPFI, then 25% of QREs must only pass 4-Part Test, remaining 75% must pass “high threshold of innovation” test
2. 4 examples provided on dual-function software
6. Process of Experimentation (POE) examples for software provided
R&D Tax Credits Cost Segregation Fixed Asset Reviews Repair v. Capitalization •Sales & Use Tax Services www.aghsts.com • Toll-Free 844.787.2121
IRS Regulation Updates
1. Alternative Simplified Credit (ASC) Allowed on Amended Returns
Final regulations issued on 2/26/2015 (T.D. 9712)
2 limitations: • Not allowed if claimed a credit using a different method in prior year(s)
• Members of controlled group may not use if any member had claimed a credit for that year and used a method other than ASC
2. Allocation of Controlled Group Credit
Final & temp. regulations issued 4/3/2015 (T.D. 9717)
Group credit is allocated based on each member’s proportionate share of aggregate QREs.
Eliminates convoluted allocation process based on each member’s stand-alone credit compared to the group credit.
R&D Tax Credits Cost Segregation Fixed Asset Reviews Repair v. Capitalization •Sales & Use Tax Services www.aghsts.com • Toll-Free 844.787.2121
IRS Updates
3. Gross Receipts from Transactions Between Group Members
Prop. Reg. §1.41-6 published Dec. 13, 2013
General rule: Intra-group transactions are disregarded.
Exception under Prop. Reg. §1.41-6 - Gross Receipts included if:
• A foreign corporate controlled group member engages in a transaction with a non-member (external transaction) involving the same or a modified version of tangible or intangible property or a service that was the subject of 1 or more intra-group transactions; and
• The external transaction does not give rise to gross receipts that are effectively connected with a trade or business within the U.S., the Commonwealth of Puerto Rico, or any U.S. possession.
R&D Tax Credits Cost Segregation Fixed Asset Reviews Repair v. Capitalization •Sales & Use Tax Services www.aghsts.com • Toll-Free 844.787.2121
Case Law
Geosyntec Consultants, Inc. v. U.S., 115 AFTR 2d 2015-644, 776 F3d 1330, 2015-1 USTC ¶50,170 (CA11, 1/29/2015)
Issue: Whether contracts were considered “funded research”?
2 types of contracts involved: I. Fixed-price contracts (aka lump sum contracts) II. Cost-plus subject to a maximum (“capped contracts”)
Court held: I. Fixed-price contracts ≠ Funded research – eligible for credit II. Cost-plus contracts = Funded research – not eligible for credit
R&D Tax Credits Cost Segregation Fixed Asset Reviews Repair v. Capitalization •Sales & Use Tax Services www.aghsts.com • Toll-Free 844.787.2121
POLLING QUESTION #4
R&D Tax Credits Cost Segregation Fixed Asset Reviews Repair v. Capitalization •Sales & Use Tax Services www.aghsts.com • Toll-Free 844.787.2121
QUESTIONS
R&D Tax Credits Cost Segregation Fixed Asset Reviews Repair v. Capitalization •Sales & Use Tax Services www.aghsts.com • Toll-Free 844.787.2121