R&D Tax Break: It. s not for lab coats and patents anymore. Reed Showalter, CPA Director, alliantgroup, LP

Transcription

1 R&D Tax Break: It s not for lab coats and patents anymore Reed Showalter, CPA Director, alliantgroup, LP 1

2 Benefit of the R&D Tax Credit Reduction in taxes Usually generates an IMMEDIATE source of cash Benefit for new AND IMPROVED software applications Additional Capital - $$$ Credit is available in all open tax years ( ) Carry-forward for up to 20 years Revenue Ruling 8249 (Use it or Lose it) Quick turnaround typically, only weeks to perform study depending on the size of the client 2

3 R&D Tax Credit Summary and Background R&D Credits Executive Summary 20,000+ firms annually claim the credit California reported the most activity with Michigan and Illinois following 1,100 firms took $5.7 B out of $7.2B (80%) Manufacturing took 68% of the credit IT took 16% of the credit State R&D credits 37 and counting Good: LA, MN, AZ, NY, CA, IN, NJ Not as good: WA, OH, MI, IL, PA, CT 3

4 Small v Large Business Effective Tax Rates R&D Background Discussion Introduction of the R&D Tax Credit: Economic Recovery Tax Act of 1981 QUALIFIED RESEARCH ACTIVITIES (QRA) 1) Discovery Test NEW TO THE WORLD REQUIREMENT 2) Contemporaneous Record-Keeping 4

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6 #1 New or Improved Business Component Business Component Purpose Matrix The Project s Business Component The Purposes of the R&D Activities related to the Function Performance Reliability Quality Durability Product Process Software Technique Formula Invention 6

7 Qualifying Industries Aerospace Agriculture Apparel and Textiles Architecture & Engineering Brewing Chemical Contractors Civil Engineering Electronics Environmental Engineering Electrical Contractors Food & Consumer Packaged Goods Foundries Furniture & Cabinet Manufacturing Mechanical Contractors Job Shops Life Sciences Manufacturing Metals Oil & Gas Software Structural Engineering Waste Management #2 Technological in Nature Includes - Hard Sciences: Research must rely on principals of hard sciences Physics Chemistry Biology Computer sciences Engineering Excludes - Soft Sciences: Research can not be in the soft sciences Economics Psychology Management sciences, etc. 7

8 #3 Elimination of Uncertainty R&D Activities Must Be Intended to: Discover information Eliminate uncertainty concerning the companies capability, process or final design. Exists if Taxpayer is Uncertain: Can We? Can company develop the business component? How? How can company develop the business component? Final Design? What will the final business component look like? #4 - Process of Experimentation Development Activities: Must evaluate a process and it s alternative Must be designed to achieve a result that was uncertain at the outset May Involve: One or more hypothesis Testing and analyzing the hypothesis Refining or discarding the hypothesis as part of a design process Must Engage in Process of evaluating & testing alternatives through: Modeling Simulation Systematic trial and error Failure: The taxpayer does not need to succeed 8

9 R&D Credits Eligible Costs (QREs) Wages Form W-2, Partnership Earnings subject to SE Tax, Schedule C Excludes 401(k) & benefits Supplies Cost to fabricate prototypes / items consumed in R&D process 65% of Contract Research Fees paid to outside consultants / engineers / software developer 41 CREDIT for INCREASING RESEARCH ACTIVITIES $5B/Yr 1981 QRA (Sec 41) QRE (Sec 174) R&D Credit (Sec 41) NEWto the WORLD US W-2s 20 % -TO YOU Contemporaneous US Contractors 6.5% Documentation -RELAXED US Supplies 2001 Proposed Regs 1) New or Improved Business Component Product / Process Technique / Design Formulation Invention Software 2004 Final Regs Jobs Creation Act" $10B/Yr 2) Based in Hard Sciences 2008 Troubled Asset Relief Programs (TARP) 2010 Small Business Jobs Act 3) Uncertainty 4) Experimentation 9

10 Fixed Base Percentage Depending on the year the company started the fix base percentage is calculated 3 different ways 1. Pre 1984 Company - the fixed base percentage is based on the level of QRE s to gross receipts during the tax years This percentage never changes and cannot exceed 16% 2. Post 1984 Company with more than 5 tax years behind it. The base percentage is a floating percentage and is based on a 10 year period using an aggregate base percentage and cannot exceed 16%. 3.For a start up company less than five years old the base percentage is fixed at 3% The Fixed Base Limitation Fixed base % = Average QREs in Base Period Average Gross Sales in Base Period Example: Fixed Base % = $100,000 =1% $10,000,000 Assuming Last 4 years average sales =$50,000,000 Fixed Base Limitation = $50,000,000 x 1% =$500,000 10

11 Base Calculations Qualified Research Expenditures Apply Fixed Base Percentage multiply QRE Floor or Fixed Base 50% of QRE Limitation multiply by 50% 50% of QREs multiply by 20% or 13% The lesser of 50% or calculated QRE over Fixed Base Regular or reduced credit Whose Credit??? Two Tests: Economic Risk and Intellectual Property Case Study Mechanical Contractor Economic Risk 75% of contracts are lump sum / fixed fee arrangements 25% of contracts are T&M for service/repair Intellectual Property Does the contractor retain a substantial right to the IP? 11

12 Credit Details Refundable vs. Non Refundable Gross Credit Reduced Credit Statute of Limitations Implication of Passive Shareholders Other Considerations Mechanics For every $1,000,000 of qualified research expenditures (QRE s): Up to $65,000 in Net Federal R&D tax credits If credits cannot be used in the year they are generated: Federal: 20 year carryforward; 1 year carryback (5 years for 2010 credits) 12

13 Utilization Losses/NOLs AMT Passive ownership ESOP Trusts 41(g) Statutory deadline considerations Controlled groups Current tax years - going forward Alternative Simplified Credit ASC equals 14 percent of the excess of current-year "QREs", over 50 percent of the taxpayer's average QREs for the prior three years. For start-up taxpayers, the credit would equal 6 percent of current-year QREs. This is also true if a taxpayer has no qualified research expenses in any one of the three preceding taxable years. 13

14 Example of ASC Calculation Increasing R&D Spending Spending QRE $85M $90M $95M $100M 50% "base" $45m Creditable amount $55m Credit (14%) $7.7M Effective credit rate % Example of ASC Calculation Declining R&D Spending QRE $115M $110M $105M $100M 50% "base" $55m Creditable amount $45m Credit (14%) $6.3M Effective credit rate % 14

15 Case Study Background Industry: Equipment Manufacturer Product: Custom manufacturer Entity Type: C-Corp Year business started: year Ave Gross Receipts: $38,000,000 Total Labor: $7,200,000 Base Method vs. ASC 15

16 Applicable Code Sections Section percent credit for increasing research and experimentation expenditures Section 56 Adjustments in computing alternative minimum taxable income Section 174 Research and experimentation expenditures Section 469(h) Passive activity losses and credits limited/material Participation defined 31 What s New? 16

17 Small Business Jobs Act of 2010 (HR5297) The small business bill will allow thousands of the most innovative and leading small and medium companies to keep hundreds of millions of dollars in their pockets. For the first time small and medium business will no longer be barred by AMT from taking the research and development tax credit, as well as dozens of other general business credits. - Dean Zerbe Eligible small business under 50 million gross receipts Tax provisions: Effective 38c turn-off 5 year carry back Signed into law September 27, 2010 Electrical Contractor Case Study Electrical Contractor in California R&D Tax Credit Company Revenue: $38MM Entity Type: S-Corporation Credit Result: $450,000 (Federal R&D Credits) 17

18 Architecture Case Study Architectural designs for hotels, healthcare, education and government R&D Tax Credit Company Revenue: $52MM Entity Type: S-Corporation Credit Result: $1,471,511 (Federal & State Credits) Electrical Contractor Case Study Construction, engineering and automation R&D Tax Credit Company Revenue: $45MM Entity Type: C-Corporation Credit Result: $648,000 (Federal R&D Credits) 18

19 Software Firm Case Study Product: Automated and digital subscription management platform to government. R&D Tax Credit Year Business Started: 2001 Company Revenue: $17MM Entity Type: C-Corporation Credit Result: $223,440 (MN R&D Credits) 37 Manufacturer Case Study Product: contract manufacturer of stainless steel, custom stainless steel equipment and systems R&D Tax Credit Entity Type: S-Corporation Credit Range: $30MM Credit Result: $271,863 (MN R&D Credits) 19

20 Manufacturer Case Study Product: Medical Devices, surgical instruments, and diagnostic equipment R&D Tax Credit Credit Range: $6.5MM Entity Type: S-Corporation Credit Result: $92,811 (Fed & MN R&D Credits) Mechanical Contractor Case Study Process piping; fabrication; BIM R&D Tax Credit Company Revenue: $25MM Entity Type: C-Corporation Credit Result: $325,000 (Federal Credits) 20

21 General Contractor Case Study R&D Tax Credit Company Revenue: $50MM Entity Type: S-Corporation Credit Result: $180,000 (Federal Credits) Civil Engineering Case Study R&D Tax Credit Company Revenue: $42MM Entity Type: C-Corporation Credit Result: $475,000 (Federal & State Credits) 21

22 Structural Engineering Case Study R&D Tax Credit Company Revenue: $16MM Entity Type: S-Corporation Credit Result: $277,000 (Federal & State Credits) Section 179D: Energy Efficient Commercial Building Deduction Established in Energy Policy Act of 2005 (EPAct) Section 179D Allows immediate depreciation deduction up to $1.80/sf for commercial buildings that achieve certain reductions in total energy and power costs Qualifying systems in new or renovated properties include: Interior Lighting HVAC and Hot Water Systems Building Envelope For public or government-owned buildings (federal, state, local) such as libraries, schools, military facilities, etc, government entity may allocate the tax deduction to designers of the property (architects, engineers, contractor, energy service providers) 22

23 Section 179D CASE STUDY EXAMPLE: Architecture firm in New York retrofitted multiple systems in five elementary schools, averaging 130,000 square feet Estimated Tax Savings $430,290 Thank you. For more information or any questions please contact: Tracy Lustyan