Friday, May 25, 2018

R&D Tax credit for businesses

Governments typically incentivize private industry to produce research and development (R&D) as a strategic tool to advance their economies. Initially temporary, the federal R&D tax credit became the United States’ primary means for rewarding business for investment in research. The PATH Act of 2015 permanently extended the R&D tax credit and expanded its provisions. The author lays out the basics of R&D tax credit and investigates the initial impact of the PATH Act by surveying its effect on 40 companies.
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Rapid changes in technology over the past decades have forced most companies to constantly innovate. At every stage, companies encounter technical challenges related to developing new or improved products and trade processes and integrating them with existing assets. Being able to overcome these technical hurdles is critical to maintaining a successful, healthy business. As most business owners know, however, attempting to create and execute viable and worthwhile innovations can be extremely expensive and time consuming for management and employees. Innovative undertakings often fail with no return on investment.

Fortunately, the federal government, as well as many states, currently provides valuable economic incentives to alleviate some of the burden and reward companies for undertaking these inherently risky initiatives. These financial incentives are intended to foster innovation and technological advancement of U.S. companies, thereby creating jobs and increasing global competitiveness.
The federal R&D tax credit, also known as the Research and Experimentation (R&E) tax credit, was first introduced in 1981 as a two-year incentive and has remained part of the tax code ever since. Its purpose is to reward U.S. companies for increasing their investment in R&D in the current tax year. It is available to any business that attempts to develop new, improved, or technologically advanced products or trade processes. In addition to activities such as creating new products or trade processes, the credit may also be available to taxpayers that have improved upon the performance, functionality, reliability, or quality of existing products or trade processes.
Although many taxpayers have viewed this tax credit favorably, there were limitations on the applicability and utilization of the tax credit for certain taxpayers. On December 18, 2015, President Obama signed into law the Protecting Americans from Tax Hikes (PATH) Act. This legislation retroactively renewed and made permanent a collection of expired tax provisions for both businesses and individuals and addressed some of the credit’s limitations with regard to certain small businesses and startup companies.

How Does the R&D Tax Credit Work?

The rules of the R&D tax credit can be found under Internal Revenue Code (IRC) section 41 and the related regulations. The R&D tax credit may apply to any taxpayer that incurs expenses for performing Qualified Research Activities (QRA) on U.S. soil.
The R&D credit comprises the following types of Qualified Research Expenses (QRE):
  • Wages paid to employees for qualified services (including amounts considered to be wages for federal income tax withholding purposes)
  • Supplies (defined as any tangible property other than land or improvements to land, and property subject to depreciation) used and consumed in the R&D process
  • Contract research expenses paid to a third party for performing QRAs on behalf of the taxpayer, regardless of the success of the research, allowed at 65% of the actual cost incurred
  • Basic research payments made to qualified educational institutions and various scientific research organizations, allowed at 75% of the actual cost incurred.
To qualify as research according to IRC section 41, the taxpayer must show that the activities—
  • are intended to resolve technological uncertainty that exists at the outset of the project or initiative, related to the capability or methodology for developing or improving the business component or the appropriate design of the business component;
  • rely on a hard science, such as engineering, computer science, biological science, or physical science;
  • relate to the development of a new or improved business component, defined as new or improved products, processes, internal use computer software, techniques, formulas, or inventions to be sold or used in the taxpayer’s trade or business; and
  • substantially all constitute a process of experimentation involving testing and evaluation of alternatives to eliminate technological uncertainty.
If the development is related to internal use software (IUS), there are an additional three tests that must be satisfied:
  • The software must be innovative. It should result in a reduction of cost or an improvement in speed that is substantial and economically significant.
  • Developing the software involves significant economic risk, requiring the commitment of substantial resources and subject to substantial uncertainty of recovery in a reasonable time period.
  • The software is not commercially available. The taxpayer cannot purchase, lease, or license and use the software for the intended purpose without having to make significant modifications that satisfy the first two requirements.
There are numerous activities that are not within the definition of qualified R&D activities. The following are 10 primary types of activities that are specifically excluded from the definition of qualified research:
  • Research conducted after the beginning of commercial production or implementation of the business component (with some exceptions)
  • Adaptation or duplication of existing business components
  • Surveys, studies, or activities related to management functions or techniques
  • Market research, testing, or development (including advertising or promotions)
  • Routine data collection
  • Routine or ordinary testing or inspection for quality control
  • Computer software, except where developed for internal use
  • Any research conducted outside of the United States
  • Any research in social sciences
  • Funded research.
The cost of acquiring fixed assets used in a taxpayer’s trade or business is also excluded.

Changes to the R&D Tax Credit under the PATH Act of 2015

The PATH Act permanently extended the R&D tax credit. Additionally, it made two very important changes effective for tax years beginning after December 31, 2015, which are intended to expand the reach of the credit. First, the legislation allows small businesses to take the R&D tax credit against their alternative minimum tax (AMT) liability for tax years beginning after December 31, 2015. The AMT restriction has long prevented qualified companies from utilizing the R&D tax credit; the legislation removed that hurdle for eligible small businesses (ESB), defined below. Second, the PATH Act allows startup businesses with no federal tax liability and gross receipts of less than $5 million to take the R&D tax credit against their payroll taxes for tax years beginning after December 31, 2015, essentially making it a refundable credit capped at $250,000 for up to five years.
Beginning January 1, 2016, ESBs can use the R&D tax credit to offset AMT. An ESB is defined as a corporation that is not publicly traded, a partnership, or a sole proprietorship with average annual gross receipts not exceeding $50 million for the three taxable years preceding the current taxable year. Special rules under IRC section 448(c)(3) apply. If the business (including predecessor entity) was not in existence for an entire three-year period, the gross receipts test applies to the period it was in existence, and gross receipts for short taxable years are annualized. For a short tax year, gross receipts are annualized by multiplying the gross receipts for the short period by 12 and dividing the result by the number of months in the short period. For a partnership or S corporation, the gross receipts test must be met both by the entity and by the partner or shareholder for the tax year.
Also beginning January 1, 2016, qualified small businesses (QSB) can use the R&D tax credit to offset the FICA employer portion of their payroll tax. A QSB is defined as a business with less than $5 million in annual gross receipts and having gross receipts for no more than five years (for 2016; not available for companies that had gross receipts prior to 2012). The election to offset payroll taxes must be made on a timely filed income tax or informational return, including extensions. In the case of a QSB that is a partnership or S corporation, the election must be made at the entity level. A small business that is not a corporation or partnership (such as a sole proprietor) must take into account the aggregate gross receipts it receives in carrying on all its trades or businesses. For corporations and partnerships, the gross receipts and the credit limitation apply on a controlled group basis.

Survey Methodology and Results

In order to gain some insight into the impact of the PATH Act, a brief survey was sent to CEOs, CFOs, vice presidents of tax, and tax directors at 40 companies, including taxpayers currently claiming a research credit on their tax returns and others who currently compute the research credit but have been limited by AMT or startup restrictions in the past. These companies came from a wide variety of industries, including food and beverage, financial services, software, chemicals, pharmaceuticals, medical devices, engineering, technology, and manufacturing. Companies surveyed ranged in size from small startup companies to companies that had more than $3 billion in top line revenue. See details below
Scale; 1; 2; 3; 4; 5; 6; 7; 8; 9; 10; N/A Question 1: Will a permanent R&D tax credit help your company increase spending on R&D? Number of Responses; 0; 0; 0; 0; 0; 0; 0; 27; 2; 3; 0 Question 2: Will the ability to use the R&D credit as an offset against AMT liability impact your business in a positive way? Number of Responses; 0; 0; 0; 0; 0; 0; 0; 0; 2; 14; 16 Question 3: Will the ability to claim a portion of the R&D credit as a payroll tax credit be beneficial to your company? Number of Responses; 0; 0; 0; 0; 0; 0; 0; 0; 0; 4; 28 Question 4: Does a permanent research credit help you with your tax planning? Number of Responses; 0; 0; 0; 0; 0; 0; 3; 3; 25; 1; 0 Question 5: Are you more or less likely to further increase your R&D spending as a result of changes in the PATH Act of 2015? Number of Responses; 0; 0; 0; 0; 0; 1; 2; 8; 19; 2; 0
Research and Development Tax Incentives for the Mechanical Engineering Industry

It’s an unfortunate truth that far too many mechanical engineering firms fail to realize that their activities may constitute qualified research and development (R&D) activities under the tax code, potentially entitling them to significant R&D tax credits. If you think you have to be a pharmaceutical company, designing a space shuttle, or operating in a laboratory to be conducting qualified activities as defined by the Internal Revenue Code, think again.

Examples of activities and innovations eligible for R&D tax incentives include the following:

  • Designing and installing heating and air conditioning systems
  • Developing ventilation systems
  • Designing plumbing systems
  • Designing piping systems
  • Installing fire protection systems
  • Conducting new product development and design
  • Designing and developing equipment
  • Fabricating or designing pumps, heat exchangers, pressure vessels, etc.
  • Designing chillers, boilers, fire heaters, etc.
  • Installing refrigeration systems
  • Developing engineering drawings and specifications
  • Performing CAD modeling
  • Achieving sustainable design
  • Introducing new or improved construction techniques
  • Researching new wastewater treatment trends
  • Conducting fluid dynamic analysis and design
  • Designing pollution control systems
  • Developing air quality detection and system
  • Exploring new toxic waste disposal processes

Friday, May 18, 2018

Flipping houses, capital asset or business operations

However, there is still a lot of confusion around taxes and flipping houses for profit. In many cases, real estate is considered a capital asset, and the sale of the home can qualify for preferential capital gain tax rates. However, when you’re in the trade or business of flipping houses for profit this may not be the case.
Normally, if you purchase a piece of real estate to fix up and sell it at later date, the profit is taxed under the capital gains rules. However, the IRS classifies individuals who actively purchase and remodel real estate for profit on a continuing basis as dealers rather than investors. For these people, the real estate is treated as inventory, rather than capital assets, and the profits on the sale of those properties is treated as ordinary income, subject to the self-employment tax.
Another source of confusion is that many potential flippers believe they can avoid taxation if they roll the proceeds of the sale into purchasing another project to flip (i.e., the property ladder theory). The truth is, if you’re considered to be in the trade or business of flipping real estate, this is not possible, as this treatment isn’t allowed for property held for resale.
House flipping is obviously a costly business, with numerous expenses incurred along the way. Most of these expenses are not immediately deductible. Instead, they must be capitalized into (i.e. added to) the basis (the original value) of the residence. Capitalized costs include:
  • The cost of the home itself
  • Direct materials
  • Direct labor
  • Utilities
  • Rent
  • Indirect labor
  • Equipment depreciation
  • Insurance
  • Production period interest
  • Real estate taxes allocable to each project
You then get a tax benefit from these expenses when you sell the property as the taxable gain is reduced by the amount of basis in property.

Thursday, May 10, 2018

Are social security benefits paid to children taxable?

Although Social Security benefits are usually paid to adults, children who have a parent who is deceased, disabled or retired can also receive benefits. Typically, a child will not receive enough from Social Security benefits to pay income taxes, but if the child has additional sources of income, a portion of the benefits might be taxable. When determining whether a child’s benefits are taxable, you must consider the child’s income separately from your own.

Thursday, May 03, 2018

Depreciation in 2018

Tax Reform: Changes to Depreciation Affect Businesses Now

As employers across the country celebrate National Small Business Week, the IRS reminds businesses that the passage of the Tax Cuts and Jobs Act may affect their depreciation deductions and taxes.

Business taxpayers can generally depreciate tangible property except land, including buildings, machinery, vehicles, furniture and equipment.

Changes to depreciation and how they will affect businesses may include:

•Businesses can immediately expense more under the new law; taxpayers may elect to expense the cost of any property and deduct it in the year the property is placed in service.

•Maximum deduction increased from $500,000 to $1 million.

•The phase-out threshold increased from $2 million to $2.5 million.

•The new law allows taxpayers to elect to include improvements made to nonresidential property. The improvements must have been made after the date the property was first placed in service.

These improvements include: 

  • Any improvement to a building’s interior
  • Roofs
  • Heating and air conditioning systems
  • Fire protection systems
  • Alarm and security systems

Improvements that do not qualify:

  • Enlargement of the building
  • Service to elevators or escalators
  • Internal structural framework of the building

These changes apply to property placed in service in taxable years beginning after December 31, 2017.

Wednesday, May 02, 2018

IRA distributed for donor's passing, distribution is still taxable

The law does not permit IRA funds to be invested in life insurance or collectibles. If you invest your IRA in collectibles, the amount invested is considered distributed in the year invested and you may have to pay a 10% additional tax on early distributions.

Small Business Week, key tax topics

For Small Business Week, IRS highlights key business tax topics

WASHINGTON — In recognition of National Small Business Week, April 29 to May 5, the Internal Revenue Service is highlighting several resources to help small business owners and self-employed individuals understand and meet their tax obligations. The new tax law changes enacted in December 2017 make it especially important for these groups to know about new provisions affecting them. 

During this week, the IRS will highlight various products including:

·        A series of news releases on various topics including the sharing economy, home office deduction, cybersecurity and the Work Opportunity Tax Credit.

·        Tax tips about business provisions under the new tax reform law. Topics will include tax law changes to depreciation rules and the employer credit for family and medical leave and how it benefits employers. Tax tips are written in plain language and can be subscribed to using the IRS’s Tax Tips email-subscription program.

·        Information for small businesses is also available through IRS social media channels including tax tips and other resources. Stay informed following the hashtag #IRSsmallbiz and help us spread these messages by sharing the @IRSnews, @IRSTaxPros and @IRSenEspanol tweets. 

Other small business resources

The IRS encourages business owners to check out other webinars on the IRS video portal. The portal has presentations on a variety of small business topics. Business owners may also be interested in these sites:

·        Small Business and Self-Employed Tax Center  — an online resource featuring links to a variety of useful tools, including Small Business Taxes: The Virtual Workshop, a downloadable tax calendar and common forms with instructions. The Center provides help on everything from how to get an Employer Identification Number online to information and tips about IRS audits.

·        Self-Employed Individual Tax Center — a resource for sole proprietors and others who are in business for themselves. This site has many useful tips and references to tax rules a self-employed person may need to know.

·        IRS YouTube Video Channel — watch videos for small businesses on the Small Business playlist.

·        Online Learning and Educational Products  — a page with tools to help taxpayers learn about taxes on their own time and at their own pace. For example, the IRS Tax Calendar for Businesses and Self-Employed has important tax dates for businesses.

·        E-News for Small Businesses —  a free electronic mail service that offers tax information for small business owners and self-employed individuals, including reminders, tips and special announcements. 

More information

Major tax reform was approved by Congress in the Tax Cuts and Jobs Act (TCJA) on December 22, 2017. The IRS has been working to implement its provisions and give information and guidance to taxpayers, businesses and the tax community as it becomes available.