Deb Roth, Managing Director, R&D Tax Consulting

Deb Roth, Managing Director, R&D Tax Consulting

A recent court case provides guidance on owner compensation and when it qualifies as a research expense under §174.  This qualification under §174 then dovetails with the §41 research and development (R&D) tax credit calculation and can have a huge impact.  Many companies are led by entrepreneurs who spend significant time developing or improving the company’s products and processes rather than managing day-to-day operations.  These qualifying activities can have a substantial impact on the size of a company’s credit.

In Eric G. Suder vs. Commissioner, Mr. Suder claimed that 75 percent of his time was devoted to research activities.  Mr. Suder was the creative genius behind the company’s products, spending most of his time guiding product development from idea generation through testing. As a result, the company grew from a one-man, garage-based startup to a thriving 125-person organization. Like many entrepreneurial CEOs, Mr. Suder spent very little time managing day-to-day operations. Instead, his time was spent contributing to senior product strategy and follow up product meetings, reviewing product specifications, and researching networking technology that could be incorporated into the company’s products.

However, the IRS disallowed Mr. Suder’s R&D credits and also challenged whether the compensation paid to Mr. Suder was reasonable under §174.  Mr. Suder argued that engineering’s role was to execute on his innovative ideas, and that his compensation was based on his creative contributions. Mr. Suder’s total compensation package during the period in question ranged from ~$8-11 million and was comprised of a base salary and bonuses, with bonuses based on growth, overall value and cash flow.

After a thorough analysis by the court, 75 percent of Mr. Suder’s salary was confirmed as qualified.   Mr. Suder was able to convince the court through documentation and oral testimony that he participated heavily in research. Mr. Suder provided credible documentation supporting his research efforts.

With respect to his compensation, according to the law, “Under §174(e) a taxpayer may deduct a research and development expenditure only to the extent that the amount thereof is reasonable under the circumstances.” The amount of an expenditure is considered reasonable if “the amount would ordinarily be paid for like activities by like enterprises under like circumstances.”  The court addressed the issue of “reasonable” with respect to how much of an owner’s compensation can be included in the credit computation.  The court evaluated eight factors including the employee’s qualifications, the nature, extent and scope of the employee’s work, the size and complexities of the business, and the prevailing rates of compensation for comparable positions in comparable concerns.

After evaluating these factors and hearing from expert witnesses for Mr. Suder and the IRS, both of whom compared Mr. Suder’s wages to those of other CEOs performing similar services in similar companies, the court determined that while they agree with Mr. Suder’s high compensation as a CEO, the amounts were unreasonable under §174.  The court determined that reasonable wages under §174 would be $2.3-2.6 million. These wage amounts represented base salary, annual incentive and long-term incentive.  The court confirmed that wage comparison should be to that of other CEOs not to that of other employees within a company or other engineers or researchers.

The Suder case highlights that owners and other highly compensated executives who participate in R&D activities can be included in calculating the R&D credit.  It also highlights the importance of supporting documentation as evidence of participation in qualified research activities.

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Charles Duncan, Director, Cost Segregation & EPAct §179D

Charles Duncan, Director, Cost Segregation & EPAct §179D

The release of final Treasury regulations on the disposition of MACRS property has increased interest in the current legal treatment of demolition costs. In general, taxpayers may now rely on the final regulations of Treasury Decision 9689 when determining how to treat asset dispositions. Though these final regulations describe when an asset disposition occurs, the related final regulations on tangible property capitalization in Treasury Decision 9636 control how to treat the demolition costs.

Under those final regulations, when a taxpayer realizes gain or loss on the disposition of an asset, the taxpayer may expense the demolition and removal costs for that asset. When the taxpayer does not realize gain or loss on an asset disposition, the costs of demolishing or removing the asset are capitalized. The following chart summarizes how to treat demolition and removal costs under the final regulations.

Transaction Type Gain or Loss Realized? Demolition/Removal Cost Treatment
Sale Yes Not capitalized (expensed)
Exchange Yes Not capitalized (expensed)
Involuntary conversion Yes Not capitalized (expensed)
Physical abandonment (whole asset) Loss only Not capitalized (expensed)
Partial asset retirement w/partial disposition election Loss only Not capitalized (expensed)
Partial asset retirement w/o partial disposition election No Capitalized to replacement asset if costs directly benefit or incurred by reason of new improvement. Otherwise, expensed.
Section 280B building demolition No Capitalized to non-depreciable land account
Conversion to personal use Gain only Not capitalized (expensed)
Transfer to supplies or scrap account Loss only Not capitalized (expensed)
GAA asset disposition, no partial disposition election and no GAA-terminating event Loss = Zero for removal cost purposes Not capitalized (expensed)

 

Please note that the above chart is based on realization, not recognition. Exchanges and involuntary conversions are often non-recognition events for federal income tax purposes. Nonetheless, they are dispositions and realization events, which dictates the treatment of asset removal costs.

Under the final regulations, demolition and removal costs are only capitalized when gain or loss is not realized. Examples of this type of situation include a building demolition that is capitalized to a non-depreciable land account under §280B or when a component of an asset is replaced without a partial disposition election. This provides taxpayers some flexibility to lower current year expenses when making structural improvements by capitalizing removal costs.

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Provisions Offer Additional Tax Benefits

In late July the Senate Finance Committee approved a modified and expanded version of the tax extenders bill that would provide a two-year retroactive extension of more than 50 expired business and individual tax provisions. Most noteworthy are enhancements to the research and development tax credit; §179 expensing provision; and the §179D deduction for sustainable design and construction of commercial properties.

R&D tax credit expansion would benefit small and medium sized businesses

The proposed R&D tax credit extension includes an AMT patch, which would allow companies paying AMT with less than $50 million in average sales over the prior three years to claim the credit. Start ups, defined as companies with less than $5 million in gross receipts and less than five years old, would be able to use the credit to offset up to $250,000 in payroll taxes annually.

Fixed asset benefits from enhancements to bill

The proposed bill would index the increased §179 expensing and phase-out limits ($500,000 and $2 million, respectively) to inflation. This is in addition to the extension of bonus depreciation and 15-year recovery for qualified properties.

Energy-efficient commercial building deduction expanded

The §179D commercial green building deduction would be expanded to allow nonprofits and tribal organizations to allocate the deduction to the primary designer of the property, a provision currently in place for government or other public entities.

If passed, all of the extenders would be set to expire on December 31, 2016. The modifications proposed for the extenders listed here could potentially provide significantly higher benefits for many small to medium sized businesses. The bill now has to make its way to the full Senate, although congressional debate will likely delay enactment until year-end.

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Charles Duncan, Director, Cost Segregation & EPAct §179D

Charles Duncan, Director, Cost Segregation & EPAct §179D

The enactment of the Tangible Property Regulations (“TPR”) has confused many taxpayers on how to deal with tenant improvements.  The most common area of confusion is whether tenant improvements may be expensed as repairs. Though the TPRs provide substantial opportunities to write off tenant improvements as repairs or maintenance, there are many traps for the unwary. The primary pitfalls are: 1) the §1245 trap; 2) the betterment trap; and, 3) the disposition trap. Taxpayers can avoid these traps by engaging experienced tax practitioners and cost segregation consultants to help navigate the TPRs.

Tenant Improvements: The Starting Point

“Tenant improvements” are not a tax concept. Both lessors and lessees can own improvements to a leased property. Though itself a complex topic, this is not the primary area of confusion. The confusion lies with the treatment of lessor improvements.

Under the TPRs, lessors must capitalize the related amounts it pays to improve a leased Unit of Property (“UoP”). These payments may be direct or indirect using a construction allowance.  Lessors must also capitalize the related amounts paid by the lessee to improve a leased UoP as a substitute for rent. Once taxpayers work through these issues to determine whether the lessor owns the improvement, taxpayers can analyze the related costs under the ten improvement tests. These tests are:

  • Betterments- An expenditure is paid for a betterment if it:
  1. Ameliorates a material condition or defect that existed prior to the taxpayer’s acquisition of the unit of property or arose during the production of the unit of property (whether or not the taxpayer was aware of the defect at the time of acquisition or production);
  2. Is for a material addition, including a physical enlargement, expansion, extension or addition of a major component to the unit of property, or a material increase in the capacity, including additional cubic or linear space, of the unit of property; or
  3. Is reasonably expected to materially increase the productivity, efficiency, strength, quality or output of the unit of property.
  • Restorations- A taxpayer must capitalize expenditures made to restore a unit of property if it:
  1. Is for the replacement of a component of a unit of property and the taxpayer has properly deducted a loss for that component (other than a casualty loss under §1.165-7);
  2. Is for the replacement of a component of a unit of property and the taxpayer has properly taken into account the adjusted basis of the component in realizing gain or loss resulting from the sale or exchange of the component;
  3. Is for the restoration of damage to a unit of property for which the taxpayer is required to take a basis adjustment as a result of a casualty loss under §165;
  4. Returns the unit of property to its ordinarily efficient operating condition if the property has deteriorated to a state of disrepair and is no longer functional for its intended use;
  5. Results in the rebuilding of the unit of property to a like-new condition after the end of its class life; or
  6. Is for the replacement of a part or a combination of parts that comprise a major component or a substantial structural part of a unit of property.

 

  • Adapt Property to a New or Different Use
  1. A taxpayer must capitalize as an improvement an amount paid to adapt a unit of property to a new or different use. An amount is paid to adapt a unit of property to a new or different use if the adaptation is not consistent with the taxpayer’s ordinary use of the unit of property at the time originally placed in service by the taxpayer.

While applying these tests to possible improvement costs, taxpayers should be aware of several traps.

The §1245 Trap

Taxpayers may be familiar with classifying building components as section §1250 (long-life) or §1245 (short-life) assets as part of a cost segregation study. These classifications are based on the former Investment Tax Credit regulations found in §1.48-1. This regulation also defines the building UoP as §1250 building property. The problem is that many taxpayers only record a single asset on their books for each tenant suite buildout without breaking down the costs into §1245 and §1250 property. Identifying property as §1245 or §1250 is not elective. Many common improvements, (such as carpeting, demountable partitions, window treatments or cabinetry), are §1245 property, the replacement of which must be treated as a new asset acquisition. This is in contrast to the replacement of §1250 property, which may often be deducted as a repair. On audit, the IRS may force taxpayers to capitalize replacement §1245 assets instead of expensing each tenant buildout as a repair. Further reading: Regulation §1.263(a)-3(j)(3), Examples 5-8 and 22 provides examples of common §1245 assets.

The Betterment Trap

In general, taxpayers focus on the restoration rules when analyzing whether lessor improvements must be capitalized. Though this is usually the correct approach, taxpayers should not neglect the possibility that some costs are attributable to betterments, especially material additions under Test 2.

This test provides that a material addition includes a physical enlargement, expansion, extension or addition of a major component to the unit of property. These tests apply at the level of the major component of the UoP. A major component is a part, or combination of parts, that perform a discrete and critical function in the operation of the UoP. For buildings, a major component can also include a significant portion of a major component. As the examples are currently written, the IRS may consider routine tenant buildouts as betterments, such as adding or removing and rebuilding partitions. Further reading: Regulation §1.263(a)-3(j)(3), Examples 8 and 22.

 The Disposition Trap

For MACRS disposition purposes, improvements and additions placed in service after the underlying asset was placed in service are separate assets. For example, a taxpayer constructs and places into service an office building. As each tenant leases its space, the taxpayer builds out that space for that tenant. Since each suite is generally placed into service after the initial building, the assets of each buildout will be considered separate assets from the underlying building. This means, instead of an elective partial disposition, taxpayers will often be faced with the mandatory disposition of an entire asset when the buildout is replaced. Since each lessor improvement generally is not a separate UoP from the underlying building, the taxpayer will be required to capitalize the replacement UoP components as a restoration under Test 4. This forces taxpayers on a path where each tenant buildout is always a restoration.

It is worth noting that this same trap may or may not apply to acquired properties, depending on the facts and circumstances. If an entire building is acquired and placed into service with all tenant suites fully occupied and finished out, the existing tenant improvements and building will constitute a single UoP of §1250 building property and a single asset for disposition purposes. The building will not fall into the disposition trap initially. Due to the §1245 trap and the betterment trap, later tenant buildouts may be improvements for repair purposes, which would put the taxpayer back into the disposition trap.

Further reading: Regulation sections 1.168(i)-8(c)(4)(ii)(D) and 1.263(a)-3(k)(7), Examples 1 and 24.

The Solution

SourceHov|Tax brings experienced cost segregation consultants and tax practitioners who can assist taxpayers and CPAs in navigating the new TPRs. With Big Four experience ranging from cost segregation to repair, disposition, and fixed asset studies, we are able to help you document your unique facts and circumstances and sustain these finding on audit.

Charles Duncan, Director, Cost Segregation & EPAct §179D

Charles Duncan, Director, Cost Segregation & EPAct §179D

As we seek solutions for ever greener buildings, the use of renewable energy sources are going to be increasingly common as are questions regarding the proper treatment of these assets. For most Alternative Energy Property, MACRS clearly proscribes a GDS tax life of five years under 00.00D, as described in §48(1)(3)(viii) or (iv), or §48(1)(4) of the Code. The question is, does asset class 00.00D apply only to assets used in the production of electricity or does it also apply equally to assets used in direct heating such as solar powered water heaters?

Wikipedia describes solar powered water heaters as:

In order to heat water using solar energy, a collector, often fastened to a roof or a wall facing the sun, heats a working fluid that is either pumped (active system) or driven by natural convection (passive system) through it. The collector could be made of a simple glass-topped insulated box with a flat solar absorber made of sheet metal, attached to copper heat exchanger pipes and dark-colored, or a set of metal tubes surrounded by an evacuated (near vacuum) glass cylinder. In industrial cases a parabolic mirror can concentrate sunlight on the tube. Heat is stored in a hot water storage tank.[i]

As with other Alternative Energy Property, solar water heaters (or combo water heater/electric generation units) are also 00.00D assets. Those assets include property described in (former) §48(1)(4) of the Code.

Former §48(l)(4) provides that “[t]he term ‘solar or wind energy property means any equipment which uses solar or wind energy–
(A) to generate electricity,
(B) to heat or cool (or provide hot water for use in) a structure, or
(C) to provide solar process heat.”

This is also a five-year statutorily prescribed recovery period from §168(e)(3)(B)(vi)(I). The only difference is that the statutory recovery period explicitly does not include property used to generate energy to heat swimming pools.

The regulations issued under former §48(l) provide that: “Section 48(l)(1) does not affect the character of property under sections of the Code outside the investment credit provisions. For example, structural components of a building that are treated as §38 property under §48(l)(1) remain §1250 property and are not §1245 property.” Treas. reg. §1.48-9(b)(1)(iii).

So these assets are five-year property, but still §1250. If installed on residential rental property, energy property also qualifies for §179, which is unusual, since §179 does not generally apply to residential rental properties.

[i] https://en.wikipedia.org/wiki/Solar_water_heating

 

Charles Duncan, Director, Cost Segregation & EPAct §179D

Charles Duncan, Director, Cost Segregation & EPAct §179D

As the first tax season under the final tangible property regulations progresses, many tax practitioners have turned their attention to the treatment of environmental remediation costs under the new regulations. Examples specifically addressing environmental remediation costs have been present in the repair regulations since they were first proposed in 2006 and are drawn from three cases and one revenue ruling issued in the 1990s and early 2000s. The final regulations present significant opportunities for tax savings or risk mitigation.

Background:

  • 1994: The Internal Revenue Service (IRS) issued Revenue Ruling 94-38. Here the IRS ruled that a taxpayer who remediates soil and groundwater contamination arising from its manufacturing process did not have to capitalize the remediation costs under §263(a), but rather the costs should be deducted under §162.
  • 1997: In Norwest Corp. v. Commissioner, 108 T.C. 265, the Tax Court held that the cost of removing asbestos was part of a general plan of rehabilitation and renovation of the underlying building and must be capitalized under §263(a). Norwest had constructed the facility in 1969. The initial construction included asbestos-containing materials. The Tax Court found that Norwest decided to remove the asbestos because the removal was essential to remodeling the building to accommodate additional personnel. As part of the remodeling process, the asbestos removal costs were capitalized under the general plan of rehabilitation doctrine.
  • 2000: In Dominion Resources Inc. v. United States, the Fourth Circuit held that a taxpayer must capitalize under §263(a) the costs of environmental remediation that adapt the property to a new and different use. Dominion Resources had operated a facility as a power plant, during which time the site was contaminated. The power plant was decommissioned and put on the market as part of Dominion’s real estate development business. After putting the property on the market, Dominion decided to clean up sludge, asbestos, and other contaminants at the site, ostensibly to limit risk to trespassers and downstream residents if the property flooded. The Court found instead that the clean-up costs allowed Dominion to put the property to new and different uses.
  • 2001: In United Dairy Farmers, Inc. v. United States, the Sixth Circuit held that the costs to remediate soil contamination from leaking underground tanks must be capitalized under §263(a). United Dairy Farmers operated retail gas stations and had unknowingly purchased two locations that had leaking underground gasoline tanks. Since United Dairy Farmers had not contaminated the property through its own business operations, the court held that ameliorating the contamination must be capitalized.
  • 2006: Treasury proposed the “Repair Regulations”. There are two examples under these regulations from United Dairy Farmers and In the first example, a taxpayer purchased land already contaminated by leaking underground tanks. Just as in United Dairy Farmers, the taxpayer had to capitalize the soil remediation costs that ameliorated a pre-existing condition. In the second example, a taxpayer undertook a remodeling project to expand its operations at a facility that it had constructed decades earlier with asbestos-containing materials. Unlike in Norwest, the asbestos-containing materials had not already contaminated the facility, but federal regulations required its removal prior to beginning any remodeling work that could disturb it. The example described the asbestos removal costs as not ameliorating a pre-existing condition. Instead, the costs were capitalized under §263(a) as costs that directly benefit or were incurred by reason of an improvement, the remodeling project.
  • 2008: Treasury issued substantially revised repair regulations. The underground storage tanks example had no substantive change. The asbestos remediation example was revised to state that the asbestos had begun to deteriorate. The example was also revised so that the asbestos removal was no longer required due to a remodeling project. With these differences, the asbestos removal costs were not capitalizable as the amelioration of a pre-existing defect. A new example drawn from Dominion Resources was added. This example required the capitalization of environmental remediation costs where a taxpayer cleans up its former manufacturing facility to sell it to a residential developer. As in Dominion Resources, these costs were characterized as costs that adapt the property to a new or different use.
  • 2011: Treasury issued the temporary Tangible Property regulations addressing not just the repair regulations but a wide variety of tangible property capitalization issues. The examples drawn from the three cases did not change substantively.
  • 2013: Treasury issued in final form some of the Tangible Property regulations, including all of the repair regulations. The underground tanks and asbestos removal examples did not change substantively. The Dominion Resources example was revised so that the taxpayer itself will develop the residential properties.

As the history makes clear, slight factual differences can drastically alter the tax treatment of remediation costs.  Ameliorating pre-existing contamination or remediation that adapts the property to a new or different use must be capitalized under §263(a). The presence of a possible contaminant, like underground storage tanks that have not leaked or asbestos in good condition does not create a pre-existing defect. If these possible contaminants require remediation arising from a taxpayer’s use of the property, the costs will often be deductible. Even if the costs are not currently deductible under the final Tangible Property Regulations, taxpayers should be advised to consider alternative routes to deductibility for prior year costs. For example, §198, which sunset after December 31, 2011, allowed a current deduction for qualified environmental remediation expenditures. These expenditures are costs that would otherwise be capitalizable and that are paid in connection with the abatement or control of hazardous substances at a qualified contamination site.  If a taxpayer can meet the requirements for 9100 relief, it can make a late §198 election.

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

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

Many companies have difficulty understanding the value of the R&D tax credit to the organization. To help put it in perspective, we recently conducted an equivalency assessment for a custom manufacturer. The chart below compares the additional revenue that would need to be generated from ordinary business operations to equal the value created by the R&D tax credit opportunity.

Gross Receipts $49,500,000
Cost of Goods Sold $40,000,000
Gross Profits $9,500,000
Total Deductions $8,000,000
Net Income $1,500,000
Profit margin 3.03%
R & D Tax credit $300,000
Revenue equivalents $9,900,000

 

The project encompassed approximately 45 hours of time by company employees, including document collection, interview participation and final deliverable review. At the conclusion, two things were worth noting:

  1. The resulting credit amount divided by the number of hours invested equated to an hourly revenue rate of more than $6,500.
  2. The credit equated to a revenue equivalency of $9.9 million. The CFO mentioned that it would take years to generate that type of top line revenue growth and impossible given only 45 hours.
  3. Even if the credit were half this amount, the company would need to grow revenues by nearly $5 million in order to achieve the same $150,000 benefit provided by the R&D tax credit.

The R&D tax credit is one of the most efficient and effective ways to create cash flow that can be reinvested into additional R&D, new equipment, talent or other areas of the business.

The SourceHOV|Tax R&D team has more than 85 years of collective R&D experience at both Big Four and boutique firms. Each member has worked with companies across a wide range of industries to complete more than 1,200 studies totaling more than $1 billion in credits claimed.

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 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

For more than 10 years, I have been talking to companies about claiming research and development tax credits. But when I learn they are in a loss position, the conversation typically stops. The argument has always been that claiming the credit while in a loss position is pointless since there is no immediate benefit.  While many companies recognize the credit, they don’t value the carryforward opportunity.   Why would a company go through the process now versus waiting until they can use it? The theory is they can always go back and capture past credits and carry the credits forward when they need them.  Plus, time is precious and resources limited.

In the past I agreed with this reasoning.  However, recently I wondered if there wasn’t value being missed. While traditional thinking seems logical, I concluded that the R&D tax credit should be included on a company’s tax return each year even if it is in a loss position. Waiting can be costly.  Here’s why:

Taxes have not gone down.  As your company grows and reverses its loss position, the credit may bring value sooner than anticipated.  Budgeting for taxes can become a very real issue and knowing what you have in reserves can help.  The carryforward of an R&D tax credit will also help with quarterly tax estimates.  When your tax position becomes positive, you will know the value of your R&D tax credits so you can offset your tax liability.

Learn it now versus figuring it out later.  Companies that claim the credit on an ongoing basis will have stronger and cleaner project tracking.  And they will better understand where internal resources are committed and where resources should continue to be dedicated.

There’s value to putting the process in place.  Establishing an ongoing process versus retroactively conducting studies is less labor intensive. Our clients find that conducting current studies simplifies the process.  They know what they need to collect and have implemented processes for data gathering throughout the year.

It’s cleaner than amending tax returns.  Each year a company goes back and captures credits to carry forward requires amending the tax return for that year.  It’s an even bigger issue for flow through companies with multiple shareholders.  In one recent case, a client with multiple shareholders wanted to capture credits from 2011-2013 and carry them forward into the current and future years for utilization. As an S-Corp with nine shareholders, they had to file 30 amended federal tax returns in addition to a similar number of state tax returns to do so.  By claiming the credit currently, you can avoid amended returns, aggravated shareholders and additional tax fees.

The credit is an asset.  For companies that are not flow through entities, the credit stays with the corporation.  As companies transition ownership, they recognize the R&D tax credit as an asset.  Many of our CPA firm partners recognize the value of such an asset and recommend their clients capture the credit prior to pricing negotiations.

 

Michael Warady, CFP has been consulting on the R&D tax credit for more than 10 years.  For the past 6 years, Michael has worked with SourceHOV|Tax clients and their CPAs to help them understand the value the credit offers.

SourceHOV | Tax has helped CPA firms and their clients maximize specialized federal and state tax incentives for more than 30 years. We’ve helped thousands of companies save billions of dollars through these lucrative tax strategies.

With the March 15 deadline looming for many of your clients, now is the time to consider any necessary tax elections for clients who plan to evaluate or take the R&D tax credit.

When a company claims a research credit, it can either elect the GROSS credit or the REDUCED credit.  When electing the reduced credit, the company makes a 280C election on the original return. This election cannot be made on an amended return.

The benefit of the 280C election is that there is no AMT impact if the company later goes back and amends the return for this credit.  If the gross credit is elected, the company must reduce its deductions by the amount of the gross credit thereby increasing taxable income.

AMT income also increases by the same amount, so companies closer to the AMT threshold may get pushed further into AMT if they go back and claim a credit under the gross credit method.   While the reduced credit is the preferred method for most companies, some (generally those with NOLs) may benefit from the gross credit method.  So an assessment should be made before making the election.

In order to make the 280C election, a company needs to determine if this election is made using the Regular Credit calculation or the Alternative Simplified Credit calculation.  To make the proper 280C election, an assessment as to which credit method will be most beneficial must be made when making the election.

For 2014, the box on Form 6765 line 17 or 34 must be checked depending on the credit calculation method chosen.

SourceHOV | Tax can analyze the benefits of the 280C election for your clients and recommend which method is most beneficial for those claiming or looking to claim the R&D tax credit.

There is still time to conduct the proper evaluation to meet the March 15 filing deadline for your clients who anticipate claiming the credit and want to make the proper election, but time is of the essence. I welcome the opportunity to discuss further how we might work together to help reduce your clients’ tax burden.

On Friday, February 13 the IRS released guidance on tangible property regulations (TPR) relief for small businesses. Requested by many small businesses and tax professionals, the simplified procedure is available beginning with the 2014 tax return.

New Rules of Rev Proc 2015-20

  • A taxpayer can employ Rev Proc 2015-20 if it’s separate and distinct trade(s) or business(es) is a qualifying taxpayer or has total assets of less than $10M as of the first day of tax year 2014, or if it has average gross receipts of $10M or less. This means that a taxpayer’s total businesses can be more than the limiting dollar criteria and still qualify for Rev Proc 2015-20 if it’s separate and distinct trade(s) or business(es) is a qualifying taxpayer or has total assets of less than $10M as of the first day of tax year 2014.
  • A taxpayer that does not file Form 3115s for 2014 defaults to the provisions of Rev Proc 2015-20 which allow the taxpayer to adopt the new regulations without filing Form 3115s for the available accounting methods.
  • A taxpayer can amend its tax return for 2014, if it already filed with TPR Form 3115s, to withdraw those filed before the due date of the return including any extension.
  • By using Rev Proc 2015-20, a taxpayer reduces the administrative burden associated with implementing the TPRs, but:
    • Does not receive audit protection for its tax years before tax year 2014 for the issues addressed by the TPRs.
    • May not scrub its depreciation schedule as of January 1, 2014 for repairs and maintenance reclassification of prior year expenditures.
    • May not claim any prior year partial asset dispositions under method #196, §6.33 of Rev Proc 2015-14. (Note: Current year dispositions may still be claimed on the tax return without filing a Form 3115.)

Conclusion

Rev Proc 2015-20 is optional for qualifying small businesses. Taxpayers can still choose to file the applicable Form 3115s and comply with the TPRs. We recommend small businesses still file the applicable TPR Form 3115s where they will have a favorable §481(a) adjustment.