In a late session Tuesday, the California Senate passed proposal AP93 that effectively repeals the California enterprise zone credit and replaces it with significantly scaled back hiring credits. The proposal largely retains the current geographic boundaries eligible for the credits and includes a sales tax exemption for manufacturing and biotech research companies as well as $30 million in the budget for tax credits that can be negotiated on a case-by case basis with the state.

The amendments would extend the carry forward provision for existing enterprise zone hiring credits to 10 years from the current five years, and a sunset provision on other parts of the program would be extended from five years or less to seven years. Additionally, ex-criminals would be eligible for hiring credits.

A priority of Governor Jerry Brown, this legislation is now headed to the Assembly where its future is uncertain.

SourceHOV |Tax is a national provider of specialty tax credit consulting services. If this legislation will cause a significant reduction in your EZ credits, we can help you identify other tax saving strategies such as R&D tax credits to offset the shortfall. For more than 30 years, SourceHOV | Tax has helped companies properly identify and sustain tax incentive strategies including R&D tax credits, cost segregation studies, 179D tax deductions and LIFO inventory accounting.  For more information, please call 800-806-7626 or visit www.sourcehovtax.com.

Michael Warady CFP, National Director, Software R&D Consulting

Michael Warady CFP, National Director, Software R&D Consulting

The year 2010 saw the launch of the iPad, Facebook market share overtake Google, Twitter go commercial and Toy Story 3 finish the year as the top domestic grossing film.  While there are many events and highlights of 2010, there is one that many may have overlooked.

On September 27, 2010, the President signed into law the Small Business Jobs Act. Even today, business owners are learning more about the act and the benefits it provides.

The act included many areas of tax savings.  One such area is the highly publicized R&D tax credit.  The R&D tax credit is one of several general business credits.  The act allowed small businesses better flexibility to utilize general business credits to offset taxes.

Software and manufacturing companies, who often qualify for the R&D tax credit, now have a much greater ability to reap cash rewards from the R&D credit. The bill allows small businesses to offset not only regular tax, which was the standard rule, but also Alternative Minimum Tax.  Companies that had previously not been able to take advantage of the credit because of this limitation are now able to see the full benefit of the credit and are paying less tax.

The second advantage provided by the act was the expansion of the ability to “carry back” the 2010 credits into prior years.  Small businesses can now carry back their 2010 R&D credits to offset the prior five years of taxes paid versus the one-year carry back that is currently and historically been in place.

There are a couple of caveats.  First, it is only available for the credits generated in the 2010 tax year–but this is still good news!  Companies with a December 31 year-end still have at least until March 15, 2014 to claim 2010 tax credits.  These credits will first offset taxes paid in 2010, any remaining 2010 credit can be carried back and used of offset both regular and AMT taxes in 2005-2009. The second caveat is that it is only available for small businesses; companies whose average gross receipts for 2007–2009 are under $50 million.  Keeping the March 15, 2014 date in mind, companies have just less than a year to go back and reclaim cash.

So, if you haven’t revisited your 2010 tax return, now is the time.  I highly recommend taking a look at your tax liability for 2010.  If you did pay tax, there are strategies available that can create tax refunds for qualifying companies.  Even S-Corporations or other flow through entities may benefit.

Michael Warady, CFP, is the National Director of Software R&D Consulting.  He has been working with companies throughout the U.S. to educate business owners and C-level individuals on the benefits and value the Research & Development Tax Credit can bring to their businesses.  He has helped bring over $150 million back to the business community through the R&D Tax Credit strategy.  Please contact Michael at (847) 914-9270 or michael.warady@sourcehovtax.com to learn more about how SourceHOV|Tax can help create additional cash flow for your business.

Deb Roth, Managing Director, R&D Tax Consulting

Deb Roth, Managing Director, R&D Tax Consulting

After a multi-year court battle over R&D tax credits claimed by Union Carbide Corporation, the Supreme Court recently denied Union Carbide’s request for certiorari.  This denial makes the Second Circuit’s affirmation of the Tax Court decision final.  The Tax Court determined that Union Carbide was not entitled to research credits for the entire amount spent for supplies.

In this case, Union Carbide conducted three research projects to improve manufacturing processes. The research was conducted on products that were already in the process of being manufactured and were ultimately sold. Union Carbide claimed research credits for the additional cost of supplies associated with the research in addition to the cost of supplies used in production.

On audit, the IRS challenged the applicability of the credit for production supplies that would have been used regardless of any research performed.

The Tax Court concluded that Union Carbide was entitled to research credits only for the additional supplies used to perform the research. Costs for supplies used for actual production were found not to be research under the tax code. According to the Tax Court, these costs were “raw materials used to make finished goods that would have been purchased regardless of whether UCC was engaged in qualified research,” and that at best, these costs are indirect research costs and therefore excluded from the definition of qualified research expenses.

On appeal, the Second Circuit agreed that the costs at issue were, at best, indirect research costs that were excluded from the definition of qualified research expenses.

The case went to the Supreme Court who on March 18, 2013, declined to review it, making the Second Circuit decision final.

This decision continues to show the importance of identifying and tracking supply costs when performing research associated with new or improved manufacturing processes,  Many of these supply costs are tracked in general “cost of goods sold” or “inventory” accounts and are not readily identifiable, making research credit claims associated with these costs more difficult to support and defend.

Deb Roth, Managing Director, R&D Tax Consulting

Deb Roth, Managing Director, R&D Tax Consulting

Governor Hassan Signs R&D Tax Credit Bill

Bipartisan Bill Doubles Tax Credit, Makes Measure Permanent

CONCORD – Enacting a key provision of her innovation plan to help businesses grow and create jobs, on March 21, 2013, Governor Maggie Hassan signed into law bipartisan legislation doubling funding for the state’s research-and-development tax credit and extending it permanently.

“Expanding the R&D tax credit is a critical component of our innovation agenda,” Governor Hassan said. “By doubling funding for the R&D tax credit, we can help more businesses develop in New Hampshire the new products that can lead to growth and job creation. Making the credit permanent will also help businesses who might need the credit down the road to plan ahead.

“Increasing funding for the research-and-development tax credit also sends a message to entrepreneurs and businesses considering where to locate that the State of New Hampshire will continue to work with them to encourage innovation and invest in our economic future.

Governor Hassan was joined for the signing ceremony by prime sponsor Senator Bob Odell and other members of the legislature, representatives from the economic development community, and New Hampshire businesses that have used the R&D tax credit, including Val Zanachuck, president of Graphicast in Jaffrey, an innovative small business that develops graphite mold casting technology to produce precision metal parts for a variety of industries.

“This legislation is a shining example of the tradition of collaborative, bipartisan problem-solving that the people of New Hampshire expect from their leaders,” Governor Hassan said. “Members of both parties, from both the House and the Senate, came together, shared thoughts and ideas, addressed concerns, and passed by overwhelming margins a common-sense measure to help businesses. By working together, we are sending a strong signal that New Hampshire is a state that welcomes innovation.”

“As a manufacturer, we have to constantly upgrade our manufacturing methods and processes to maintain a competitive business,” Val Zanchuck said. “New product development and process improvements are our R&D. For us, this R&D does not take place in a laboratory, it takes place on the shop floor. The R&D tax credit helps provide resources that we reinvest to improve and accelerate these activities.”

In addition to expanding the R&D tax credit, the Governor’s “Innovate NH” jobs plan focuses on building the best workforce in the country by making higher education more affordable and on providing businesses with technical assistance to help them create jobs.

Governor Hassan’s fiscally responsible, balanced budget substantially restores cuts made to New Hampshire’s public universities and community colleges in exchange for freezing in-state tuition for the next two years. Her budget proposal also will help New Hampshire’s businesses grow and attract new companies with good jobs by supporting economic development efforts, funding business incubators, and providing businesses with support to help them enter new markets around the world.

Chandry Jimenez, Director of IPIC LIFO Services

Chandry Jimenez, Director of IPIC LIFO Services

While there is no current timetable for the adoption of International Financial Reporting Standards (IFRS) for U.S. companies, the looming conversion has long been a source of concern for companies using the Last In First Out (LIFO) method of accounting. Because IFRS does not recognize the LIFO method, full adoption of IFRS by the Securities and Exchange Commission would force companies off of LIFO for tax purposes, since the conformity rule requires companies using LIFO for tax purposes also use LIFO for financial statement reporting.

However, recent developments should provide LIFO taxpayers relief and cause less worry about the impact IFRS conversion may have on their business. In a recent memo addressed to The LIFO Coalition, Les Schneider, Tax Counsel to The LIFO Coalition, explains that it is increasingly unlikely that the SEC will fully adopt IFRS or disallow the LIFO method. It is very possible, under the form of convergence currently being contemplated by the SEC, that LIFO will remain an acceptable method in spite of the fact that it is not recognized by IFRS.

LIFO repeal has also been a threat on the legislative front, appearing in President Obama’s budget multiple years. While there is currently no pending legislation calling for the repeal of LIFO for tax purposes, an argument always used by legislators when discussing LIFO repeal is the impending IFRS convergence. With it being increasingly unlikely that a full IFRS adoption and disallowance of LIFO for financial statement purposes will take place, legislator’s LIFO repeal argument has certainly become less valid. Any future legislative efforts arguing the use of LIFO for tax purposes will certainly become more difficult.

LIFO is an established tax method that has been a part of U.S. tax law for over 80 years and is used by hundreds of thousands of companies that carry inventory across all types of industries.

Please contact me for additional information at chandry.jimenez@sourcecorptax.com.

Attempt to Subdivide Component Assets Identified by Cost Segregation Study Deemed “Immaterial”

A number of our clients have expressed concern about a recent tax court case where the court disallowed reclassification of assets identified by a cost segregation study. After careful review, we concluded that the decision is a narrow one and will likely not apply beyond the facts in this case. We believe that the decision will not readily apply to all purchase price allocations.

In Peco Foods, Inc. & Subsidiaries, Petitioner v. Commissioner of Internal Revenue, Respondent ( T.C. Memo 2012-18) the tax court upheld the decision of the Internal Revenue Service precluding Peco Foods from modifying purchase price allocations of two processing plants it purchased in 1995 and 1998. The court upheld the terms of the respective asset purchase agreements, which the buyer and seller had agreed to at the time of the purchases.

The purchase agreements contained provisions in both allocation schedules stating that “the parties would use these values for all purposes including tax and financial reporting,” making the contracts binding unless Peco could prove they were unenforceable. The court determined that Peco’s decision to allocate the purchase price among machinery, equipment, and furniture showed that it was aware of the specific component assets but chose not to allocate additional purchase price to those assets. Therefore the court determined that Peco intended the asset described as “Processing Plant Building” to be treated as a single asset.

The court also found that Peco believed the term “Processing Plant Building” was ambiguous only after it perceived a benefit could be realized by subdividing the building into component assets. Therefore, the court ruled that there was no ambiguity in the term.

Peco agreed to allocate the purchase price of the plant among three assets: Real Property: Land, Real Property: Improvements,” and “Machinery, Equipment, Furnitures and Fixtures.”

The court determined that the decision to allocate the purchase price separately among these various assets showed that Peco was aware of the existence of subcomponent assets but chose not to allocate additional purchase price to them. The court also determined that had Peco intended to allocate purchase price to subcomponent assets, it would have done so by allocating additional purchase price to the asset described as “Machinery, Equipment, Furnitures and Fixtures.”

In addition, the appraisal for the second plant was dated prior to the date on which Peco entered into the agreement, suggesting that Peco could have adopted a more detailed allocation schedule into the agreement but chose not to.

The second agreement contained a merger clause providing that the contract, accompanying exhibits, and closing documents “constitute the entire agreement between the Parties.” The court determined that this clause creates a presumption that the writing represents a “final and complete agreement of the parties.”

The court never reached the issue of cost segregation when it ruled that the agreements were not ambiguous and that whether the acquired assets may be subdivided into component assets was immaterial because Peco may not deviate from its characterization of those assets as stated in the original allocation schedules.

Because Peco Foods attached a statement to Form 8594 allocating specific amounts of the Purchase Price to Processing Plant Buildings and Real Property Improvements, they cast the allocations in stone. The tax court found that the agreements were enforceable, the terms were unambiguous, and all relevant assets were covered. Peco claimed that it could reallocate the useful lives of assets under Code Sec. 338(b)(5), the “residual method,” which applies when the parties do not agree in writing as to the allocation of any part of the consideration. However, since all assets were covered by the agreements, and the agreements were enforceable, the residual method did not apply.

Because the original documents went into the level of detail of identification they are bound to stay within those allocations. In our experience, agreements containing such specificity are rare. Therefore, we don’t expect any significant impact from this ruling nor do we anticipate an appeal.

Chris Henderson, VP of Operations

Chris Henderson, VP of Operations

SourceCorp recently experienced a situation where an auto dealer was notified by the IRS that their 2008 and 2009 tax years were the subject of a routine IRS exam. The IRS also indicated it would be looking at §263A issues during the exam. After some negotiation, the IRS said it was willing to drop prior year §263A issues if the auto dealer elects the Safe Harbors as outlined in Rev. Proc. 2010-44. In addition, the IRS required the dealer to adopt the Safe Harbors via Form 3115 for the 2010 tax year by the 9/15 extended due date.

The IRS’ willingness to allow the dealer to move to Safe Harbor methods is in keeping with what IRS Motor Vehicle Specialist Terri Harris relayed late last year when the Safe Harbor guidance came out. Terri’s comments indicated that the IRS would be lenient on dealers for the 2010 and 2011 tax years, giving them time to transition to the Safe Harbors method. After that, dealers may face less forgiving IRS agents.

SourceCorp works with many auto dealers and their CPAs and has developed a seamless solution for the adoption of both safe harbors. We continue to monitor this issue closely and will post additional updates to our blog as they arise. For further information, contact me directly at chris.henderson@sourcecorptax.com.

Chris Henderson, VP of Operations

Chris Henderson, VP of Operations

In January 2011, the IRS issued Revenue Procedure 2011-14 that provided an alternative accounting method for claiming the EPAct 179D tax deduction for sustainable design. Rather than amending tax returns, architectural firms that had not previously taken the deduction were allowed to claim the deduction on their current year’s return using a Form 3115 along with a certification report and an allocation letter.

However, this week, IRS author of 179D guidance, Jennifer Bernardini provided clarification with regard to Form 3115. While admitting that ambiguity exists in Rev Proc 2011-14, she stated the Office of Chief Counsel, the IRS division that reviews accounting methods, was unlikely to grant any accounting method change submitted by architects that have not previously claimed the 179D deduction. She also indicated the IRS is working on guidance that would clarify the ambiguity found in Rev Proc 2011-14 but gave no timetable.

While Ms. Bernardini’s comments represent her own opinion and not those of the IRS, her comments can be interpreted as the prevailing thought at the Service. As such, SourceCorp recommends filing amended returns to claim 179D deductions associated with projects completed in prior tax years. To ensure that all 2008 projects are reviewed while still under statute, firms should gather complete blueprints and specifications as well as applicable allocation letters as quickly as possible.

SourceCorp is keeping close tabs on this issue and will communicate further updates.

Chandry Jimenez, Director of IPIC LIFO Services

Chandry Jimenez, Director of IPIC LIFO Services

Equipment Manufacturer

A manufacturer of safety and personal protective equipment had been experiencing steady increases in material costs. The company had utilized the LIFO inventory method in the 1990s, but elected off of LIFO due to the complexities associated with the method. They decided to consider LIFO again as a means to free up cash to reinvest in the business for the 2010 tax year. A no cost analysis by SourceCorp Professional Services showed the company was experiencing 4% inflation, which yielded a first year LIFO Reserve of over $4.1 million – a tax deferral of over $550,000 in year one, which the company used to expand their business. They were also able to eliminate the concerns and complexities presented with their prior LIFO method by utilizing SourceCorp’s services.

Distributor

An aluminum distributor with roughly $20 million in inventory had been on LIFO for 15 years. While their current method had produced a sizeable LIFO Reserve over the years, the company was open to considering other LIFO methods. By changing to the IPIC LIFO method, the company was able to increase their LIFO Reserve by $2.5 million above their prior method for the 2010 tax year. The audit protection received as a result of the method change proved to be an additional benefit of electing IPIC.

From Federal Tax Updates Checkpoint Newsstand May 31, 2011

Businesses that trade in machinery or equipment for which they claimed bonus depreciation under Code Sec. 168(k) may qualify for another bonus depreciation deduction on the remaining depreciable basis if they swap for like-kind property that also is eligible under Code Sec. 168(k). In effect, the business gets two bonus depreciation deductions for its expenditure on the traded-in property. What’s more, this result is explicitly OK’d by the regs.

Background. Bonus first-year depreciation deductions are available for a property if: (1) it is property to which the modified accelerated cost recovery system (MACRS) rules apply with a recovery period of 20 years or less, computer software other than computer software covered by Code Sec. 197, qualified leasehold improvement property, or certain water utility property); (2) its original use commences with the taxpayer; and (3) it is timely bought and placed in service by the taxpayer.

The bonus first-year depreciation allowance is:

• 50% of the cost of qualified property acquired and placed in service after Dec. 31, 2007, and before Sept. 9, 2010;
• 100% of the cost of qualified property acquired and placed in service after Sept. 8, 2010 and before Jan. 1, 2012 (before Jan. 1, 2013 for certain longer-lived and transportation property); and
• 50% of the cost of qualified property acquired and placed in service after Dec. 31, 2011 and before Jan. 1, 2013 (after Dec. 31, 2012 and before Jan. 1, 2014 for certain longer-lived and transportation property). (Code Sec. 168(k)(2), Code Sec. 168(k)(5))

Note that 50% bonus depreciation also applied for certain qualified property acquired after May 5, 2003 and before Jan. 1, 2005, and 30% bonus depreciation applied for certain qualified property acquired after Sept. 10, 2001, and before May 6, 2003.

MACRS property may be acquired (1) in exchange for MACRS property in a Code Sec. 1031 like-kind property exchange, or (2) to replace involuntarily converted MACRS property in a Code Sec. 1033 involuntary conversion. (Reg. § 1.168(i)-6(c)(1)) The replacement property is for depreciation purposes divided into the depreciable exchanged basis (i.e., remaining basis of the relinquished property carried over to the replacement property), and the depreciable excess basis (i.e., additional consideration to acquire the replacement property). Where the properties share the same recovery class and depreciation method, the depreciable exchanged basis is written off over what’s left of the relinquished property’s recovery period; and the depreciable excess basis is in effect treated as a separate property with a recovery period that begins anew. (Reg. § 1.168(i)-6(c)(3)(ii))

Double helping on bonus depreciation. When otherwise eligible MACRS property or computer software is acquired via a Code Sec. 1031 like-kind exchange or as a result of a Code Sec. 1033 involuntary conversion, both the carryover basis and the excess basis, if any, of the acquired property are eligible for bonus depreciation. (Reg. § 1.168(k)-1(f)(5)(iii)(A)) What’s more, it doesn’t matter if bonus depreciation was claimed on the old property. (Reg. § 1.168(k)-1(f)(5)(vi), Ex. 3)

RIA illustration: In January of 2010, ABX Corp. bought a new refrigerator truck (5-year MACRS property) for $100,000 and placed it in service that year. In 2011, ABX acquires another new, higher-capacity refrigerator truck in exchange for the truck bought in 2010 by trading in that truck and paying $50,000 cash. ABX uses the optional rate tables to compute depreciation and is subject to the half-year convention in 2010 and 2011.

For 2010, ABX claimed 50% bonus first-year depreciation for the truck bought and placed in service that year. As a result, its 2010 depreciation deduction for the truck was $50,000 of bonus depreciation (.50 × $100,000) plus $10,000 of regular first-year depreciation allowance (.20 recovery year one table percentage for 5-year property × [$100,000 − $50,000 bonus depreciation]), for a total of $60,000.

For 2011, ABX claims an $8,000 depreciation deduction (.32 recovery year two table percentage for 5-year property × [$100,000 − $50,000 bonus depreciation] × 6/12 [half-year convention applies]) for the relinquished truck.

ABX may claim a 100% bonus first-year depreciation deduction for the $32,000 remaining depreciable basis of the relinquished truck, i.e., the depreciable exchanged basis ($100,000 cost − $60,000 − $8,000). ABX also may claim a 100% bonus first-year depreciation deduction for the $50,000 in cash that it pays to acquire the upgraded refrigerator truck.

RIA observation: In essence, for bonus depreciation purposes, the regs treat a taxpayer like ABX as if it had sold the old truck for its remaining depreciable basis and then used the proceeds, along with additional cash, to purchase a new one.

RIA caution: This won’t work if the older-model truck was acquired in January of this year and the newer model in December. Under Reg. § 1.168(k)-1(f)(5)(iii)(B), bonus depreciation isn’t allowable for the exchanged (or involuntarily converted) MACRS property if the exchanged (or involuntarily converted property) is placed in service and disposed of in a like-kind exchange or involuntary conversion in the same tax year.

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