http://www.dispatch.com/content/stories/local/2012/05/09/delaware-ems-study-shows-how-much-county-doesnt-pay.html

What is it?

The Domestic Production Activity Deduction (“DPAD”) has rattled around in Congress since 2004.  It was first passed in 2004, then amended retroactively in 2005, and then amended again in 2006.  The DPAD encourages domestic production activities through a tax deduction benefiting businesses and individual taxpayers who engage in those production activities.

Commencing with 2005, businesses engaging in domestic production activities may deduct an applicable percentage of their qualified production activities income (as defined below, “QPAI”).  As with most tax benefits, the DPAD suffers from various qualifications and limitations, which may limit/preclude the deduction’s size or availability.  The most critical limitation ties the DPAD’s size to paid wages which ensures that most of the DPAD’s benefit goes to businesses either creating and maintaining jobs.

When did the DPAD start?

The DPAD is effective for corporations and individuals for taxable years beginning after December 31, 2004.  It is available to partnership and S corporation owners for entity taxable years also beginning after December 31, 2004.  Collectively, corporations, partnership and S corporation owners and individuals are referred to as “qualifying businesses”, subject to the law’s definitions briefly discussed below.

How does the DPAD work?

Qualifying businesses deduct a percentage of their QPAI from taxable income (for corporations) or adjusted gross income (for individuals).

                Tax Year:                                   Applicable Percentage of QPAI:

                 2005-6                                                                            3%

                2007-9                                                                             6%

                2010—                                                                              9%

For instance in 2010, the DPAD is equivalent to a 3% tax rate reduction for qualifying income, assuming a corporate tax rate of 34%.

The DPAD may be effective for state tax purposes too, although some states may “decouple” from the federal deduction to avoid business tax revenue losses.

Who/what qualifies?

What products qualify?

DPAD qualifying production property includes: (1) “tangible personal property”, (2) computer software, and (3) sound recordings; but does not include: (a) prepared food and beverages sold at a retail establishment, (b) leased, rented, licensed, sold or exchanged land, and (c) any property leased, licensed or rented to a related party.  So, in most general terms this seems to encompass traditional manufacturing activities, the production of agricultural products, and the traditional extractive industries.

“Tangible personal property” means any tangible property (including any gas, other than natural gas, chemicals, steam, oxygen, hydrogen, and nitrogen), other than land and certain real property, computer software, sound recordings, qualified films, and utilities.

Property is produced “in whole or significant part in the United States” if the incurred US direct labor and overhead costs are at least 20% of the property’s total cost of goods sold.  In transactions without cost of goods sold (i.e., lease, rental, or license), the US incurred direct labor and overhead must be at least 20% of the taxpayer’s unadjusted depreciable basis in the property.

There’s a maze of rules regarding allocations of receipts and expenses to domestic production activities within the IRS regulations.  Your H&M tax consultant can guide you through them.

What businesses or activities qualify?

DPAD qualification largely depends on the nature of the business as its underlying theme is the encouragement of U.S. job formation.  As with many legislative pieces “favored sons” exist.  Their qualification is made relatively simple.  These businesses are: (1) film production where at least 50% of the compensation is paid for services performed in the United States; (2) the sale (but not transmission or distribution) of electricity, natural gas, or potable water produced in the United States; (3) construction of real property in the United States; and (4) engineering and architectural services performed in connection with U.S. real property construction.

The economic activities qualifying for the DPAD should benefit most businesses.  These “activities” include the lease, rental, license, sale, exchange or other disposition of “qualifying production property”; provided, that, it’s manufactured, produced, grown, or extracted by the taxpayer “in whole or significant part in the United States”.

As one can imagine, these defined terms are fraught with complexity in the IRS regulations; if you have questions you should consult your H&M tax consultant for clarification.

How is the DPAD calculated?

Once a business and its activities qualify, its “qualified domestic production receipts” are reduced by: (1) cost of goods sold; and (2) other expenses, losses, and deductions (other than the deduction for domestic production activities) that are, in each case, allocable to those receipts.  The result is the taxpayer’s qualified production activities income (“QPAI”), to which the taxpayer applies the applicable percentage to determine its DPAD; provided, however, the actual DPAD may not exceed 50% of the taxpayer’s W-2 wages for the taxable year.  However, for tax years beginning after May 17, 2006, this wage limitation is modified so only W-2 wages properly allocable to qualified domestic production receipts are considered in such limitation.  Thus, businesses relying primarily on contractors, or requiring only a small employee base, may have a decidedly smaller DPAD than anticipated.

Where to start?

The DPAD and its related provisions contain numerous traps for the unwary, and place a premium on planning/organizing your production activities for both DPAD qualification and maximization.  Your safest bet is to involve your H&M tax consultant at the earliest stage possible.   

To learn more about the Domestic Production Activity Deduction and how it could be applied to your business, contact Stephen C. Smith or your Holbrook & Manter representative.  We have facilitated tax savings for a number of growth-minded clients.

Uncle Sam suggests just a few more things to consider as you prepare for your big day:

 1.       Notify the Social Security Administration of any name change so that your name and Social Security number will match when you file your next tax return.  File a Form SS-5, Application for Social Security Card available at www.ssa.gov or by calling 800-772-1213 or at your local Social Security office.

2.       Notify the IRS of any change of address by filing Form 8822, Change of Address available from www.IRS.gov or order it by calling 800-TAX-FORM (800-829-3676).

3.       Notify the U.S. Postal Service of any change of address so that it can forward any IRS correspondence or refunds.

4.       Notify your employer of any change of name or address to make sure you receive your Form  W-2, Wage and Tax Statement after the end of the year.

5.       Check your withholding to be sure that you are having the proper amount of tax withheld as your combined income may place you in a higher tax bracket.  The IRS has a withholding calculator available at www.IRS.gov to help you complete a new W-4, Employee Withholding Allowance Certificate if one is needed.  The W-4 form is also available on the IRS website.  Print it off, fill it out and give it to your employer.

6.       Select the right tax form as you and your spouse may now have enough deductions to itemize.  If you have been filing a 1040A or 1040EZ you may now find the 1040 long form to be the most advantageous.

7.       Choose the best filing status – Your marital status on December 31^st determines whether you are considered to be married for that year.  Even though you are married you may find that your total Federal and State tax bill together is less if you file separately.  Figure your taxes both ways to be sure to minimize your overall tax burden.

If you should need any help or assistance with any of these items, please do not hesitate to give us a call. 

With a struggling economy limping its way into 2012, many previously successful corporations find themselves in desperate straits.  One of the consequences of a weak economy is generating “net operating losses (“NOL”).  At times when all else fails, a corporation’s un-utilized NOL becomes its most valuable asset.

However, usually before corporations sell their NOLs, they (and their owners) try mightily to “turn-around” their operations.  Those efforts are funded by loans or capital contributions from both current owners and “angels”.  An NOL’s value to a third party is controlled by an evolving provision in the Internal Revenue Code (the “IRC”).  Correspondingly, shepherding the NOL’s value becomes a meaningful exercise.

Transferring corporate NOLs -

Historically, Congress and the Internal Revenue Service (the “IRS”) took repeated steps to restrict and devalue NOLs transferred to those who didn’t create them. 

Caveat:  Discussions of the “separate return limitation year” (aka “SRLY”) consolidated return regulation limitations are beyond the scope of this web piece, but the ensuing discussion below is applicable in both consolidated and separate return environments.  See Treas. Reg. § 1.1502-21A(c), et. seq.

Early on, IRC § 382 restricted “trafficking in NOLs” be denying an NOL’s use by an acquirer if the NOL’s acquisition was tax avoidance motivated.  Using a subjective standard was not satisfactory to both taxpayers and Congress. 

This “early” subjective standard was subsequently replaced by an “objective” standard.  Generally, the objective standard imposes a limit on the NOL’s use if during a three (3) period a more than 50 percentage point increase stock ownership among 5% owners occurs.  If such ownership change occurs the corporation’s NOL whose stock is the subject of the ownership change can only be applied to that amount of income equal to the product of the corporation’s fair market value (“FMV”) at the time of the ownership change multiplied by the “federal long-term tax-exempt rate” (aka the “382 Limit”).

The FMV factor within the 382 Limit was frequently inflated by current owner-pre-ownership change capital contributions.  Customarily, the price of the acquired corporation’s stock was increased by the amount of those capital contributions making those contributions’ real substance the inflation of the 382 Limit (i.e. the amount of income against which the acquired NOL could be utilized). 

IRC § 382 was amended to prevent this “scheme” by adding “anti-stuffing” provisions. 

When is a capital contribution within the “anti-stuffing” trap?

If a capital contribution is within the “anti-stuffing” provisions it isn’t part of the loss corporation’s FMV and hence the 382 Limit is unaffected.  Generally, any capital contribution made within two (2) years of the ownership change is presumed to be part of a plan a principal purpose of which is to avoid or increase the 382 Limit, unless the regulations provide otherwise.   In short, well intentioned capital contributions made to “save the corporation” are at risk of being snared by the anti-stuffing provisions.

Relief – maybe yes; maybe no -

This two (2) year “presumption” was ameliorated in 1986 Congressional Committee Reports where (a) capital contributed at the corporation’s formation, (b) contributed prior to incurring losses, and (c) capital contributed for basic working capital they aren’t to be part of “stuffing”.  The IRS articulated four (4) “safe harbor” anti-stuffing presumption limitations in an notice. 

The safe harbors are unfortunately hyper-technical so owners of “loss corporations” with un-utilized NOLs should contact their H&M tax advisor before attempting, or permitting others, to make contributions to the loss corporation’s capital.

Income levels:

Your tax audit probabilities increase dramatically with increasing income levels.  Overall an income tax return’s audit probability is about 1.1%.  If your income level is $ 200,000 or higher the probability increases to nearly 4%.  Income levels of $ 1 million or greater produce tax audit rates of nearly one in eight (over 12%).   This is a surprising way to reward success?

Unreported income:

Many forms of income are reported on 1099 forms which are sent to both to the taxpayer and the IRS.  When your return is filed, the IRS compares your reported income with their received 1099 forms.  If there’s a disconnect, you will hear from them.  This can often be the impetus for a more fulsome tax audit too.

Large claimed charitable deductions:

Charitable deductions have come under substantially greater IRS scrutiny.  Inadequate substantiation for cash contributions, not reporting non-cash contributions on form 8283 or failing to secure appraisals on property contributions over $ 5,000 can attract undesired IRS attention.  As with many tax issues proper records, proper records and proper records are the three (3) most important defenses.

Home office deductions:

IRS has identified home office deductions as an area with great tax deficiency potential.  If you’re claiming such a deduction it’s wise to work with your H&M tax advisor to avoid unpleasant IRS encounters.

Employee/independent contractor Issues:

The magnitude of employment taxes on “common law employees” spawned serious tension over service provider classifications (i.e. employee versus independent contractor). 

Many businesses err, and continue to err, on the side of independent contractor classification hoping to avoid a plethora of administrative and benefit costs and tax burdens.  In 1978, the battle had raged to such a degree that Congress stepped into the fray with “Section 530” which limited the IRS’ ability to reclassify service providers as employees rather than independent contractors.  Subject to satisfying a series of compliance hurdles, this area has been somewhat subdued.  Recently the IRS announced the “voluntary classification settlement program” (aka the VCSP).  Usually such IRS overtures are in essence a “fair-warning” that increased/intensified enforcement is commencing. 

If you have long-term 1099 service providers who generally work exclusively with your business you should contact your H&M tax advisor for a determination of your business’ risk level.

Rental losses:

Rental losses are generally deductible only against passive income, unless you meet either the small rental exception or the real estate professional exception. 

The former exception is limited to $ 25,000 in losses and generally phases-out at income levels between $ 100,000 and $ 150,000. 

The latter exception pertains to folks like developers, brokers, professional landlords etc.  This exception requires “material participation” (or 750 hours per year) which makes proper aggregation of properties critical. 

These “passive activity” byzantine rules make IRS audits of such activities particularly fruitful from the IRS’ perspective. 

If you don’t meet either of the above exceptions, let us discuss with you the limitations that exist when you rent property to your own company.  You can’t use the self-charged rent as “passive income” to deduct your other leasing losses.

Meals and entertainment expenses:

Besides the critical correlation between these expenses and your business, expense substantiation is frequently lacking and proper application of the statutory limits make the IRS think audits in this area are almost too easy.  Records and good contemporaneous diaries are critical for success in these examinations.

Claiming 100% business use on a vehicle:

Insofar as commuting, driving to lunch or a doctor’s appointment are seldom a “business use” of a vehicle, claiming 100% business use on any vehicle except one which is unsuitable for personal use is like waiving a red flag at an IRS bull.   Moreover, since employer-provided vehicles most frequently require income inclusion by the person using the vehicle, ignoring personal use reporting requirements just increase the probabilities of penalty assessments.

Hobby loss activities:

Many high income earners engage in pseudo businesses that combine a “recreational” interest with an activity masquerading as a business.  The tax court is littered with the bodies of hobbies hiding behind facades that were easily detected at the audit level.  If you find yourself in these waters, maintain great books and records, secure outside consultants to assist with generating profits and be willing to abandon the project when several unsuccessful years have elapsed.

Higher than average deductions:

The IRS spent decades statistically measuring tax aspects of filed returns.  They’ve created correlations between income levels and certain customary tax deductions.  If your deductions are decidedly outside their “standard deviation” expect to receive a visit.  Expect high document production requests so if you’re on the “bubble” speak with your H&M tax advisor to aid in improving your deduction record keeping.

Cash intensive businesses:

Cash-flow audits have become very commonplace.  Agents report that businesses where receipts are mostly cash frequently have unreported or underreported income as well as questionable deductions.  If your business’ receipts are largely in the form of cash remember that the IRS will not only look at your business accounts but any other financial account over which you or your spouse have signature authority.

These examinations are no joking matter as they can move rapidly from a typical “civil tax” matter to one where Miranda rights are involved. 

Moreover, using bank accounts to “wash” out cash transactions are subject to IRS notification.  The $ 10,000 transaction limit isn’t the protection it once was as banks must report suspicious transactions, like a series of $ 9,500 transactions, the principal purpose of which was to avoid the $ 10,000 transactional limit.

Foreign bank and financial accounts:

The previous topic is a good lead-in for these subjects.  Many US persons have, or have been convinced to have, funds outside the US.  Disclosure of foreign bank account interests has been with us for some time, but compliance lagged which led to an “amnesty program”.  The penalties were on some occasions quite high, but generally full disclosure prevented “criminal” issues.    When disclosure wasn’t made, people had UBS-type experiences. 

While the amnesty programs were successful, the IRS has vigorously pursued information exchange demands with banks in many “bank secrecy” nations.  While disclosure isn’t that pleasant, imagine your prospects if the IRS discovers your accounts before you disclose!  

This can be a particularly tough issue for US persons who have been long-term foreign residents. 

In 2011 this scope of inquiry expanded to financial accounts, brokerage or not, and foreign issued securities.  If you have any such accounts/investments you should speak to your H&M advisor to keep a target off your  back.

For most new or used non-real property assets purchased, the Section 179 deduction limit for 2010 and 2011 is $500,000 with the limit reduced dollar for dollar (but not below zero) by the cost of qualifying property over $2 million.  The deduction for qualified real property is limited to $250,000.  Deductible Section 179 is also limited to the taxpayer’s business taxable income.  Vehicles are generally limited to $8,000 in addition to regularly allowed first year depreciation.

Qualified real property includes the following:

• Qualified Leasehold Improvement Property – generally improvements to nonresidential building’s interior made pursuant to a lease.
• Qualified Restaurant Property – generally buildings and improvements if over 50% of the building’s square footage is devoted to the preparation and consumption of meals.
• Qualified Retail Improvement Property – generally improvements to a nonresidential building’s interior areas that are open to the general public for a building used in a retail business selling tangible personal property to the general public.

100% Bonus Depreciation Rules for 2010 & 2011

Most qualifying new assets that are acquired and placed in service after 9/8/2010 and before 2012 (2013 for certain long-production property and aircraft) can be written off 100%.  Vehicles are generally limited to $8,000 in addition to regularly allowed first year depreciation.

Which is Better?

If both the Section 179 deduction and 100% bonus depreciation are available there are some considerations to keep in mind:

• Assets expensed under Section 179 are not counted toward determination of whether nor not the mid-quarter convention applies but basis deducted as bonus depreciation is.
• Neither bonus depreciation nor Section 179 requires an alternative minimum tax adjustment.
• Section 179 applies to new or used assets while only new assets qualify for bonus.
• Qualified leasehold improvement property, but not the other two types, qualifies for bonus unless they also meet the requirements for qualified leasehold improvements.
• Bonus depreciation must be claimed or elected out of by class.  Section 179 is elected on an asset by asset basis and can be used to expense less than the full amount of the asset’s basis.
• Bonus depreciation is not limited by taxable income and can be used to create an NOL that can be carried back and perhaps used immediately.
• Although most Section 179 taken in excess of taxable income can be carried forward indefinitely, Section 179 claimed on qualified real property cannot be carried past the 2011 tax year.
• The asset must be used over 50% of the time for business to qualify for Section 179.  If the usage later falls below 50% business usage the Section 179 must be recaptured.  Except in the case of listed property the 50% business usage is not a requirement for bonus depreciation.
• For Ohio taxpayers, Section 179 over $25,000 and all bonus depreciation must be taken over 6 years.  Many other states have similar limitations.

The Deduction also provides tangential benefits in the form of rebates from utility providers such as American Electric Power and low interest financing sponsored by the Ohio Department of Development.

Regrettably, this deduction is used by only about ten percent (10%) of otherwise qualifying projects. And, it is probably even less frequently considered in the cost/benefit analyses of most renovation projects. Don’t have regrets; save money and taxes!

How Does the Deduction Work?

The Deduction can reward companies and building owners who make qualifying improvements to a building’s envelope (the “Envelope”), the HVAC/hot water systems (collectively, the “HVAC”), and the interior lighting systems (“Lighting”). You should bear in mind that this Deduction is a source of ordinary income for recapture purposes on the disposition of depreciable personal and real property.

The technical standards for the Deduction are beyond the scope of this piece. However, in general terms, if these building system improvements result in a fifty percent (50%) reduction in the building’s energy/power costs (when compared to a “reference building”) this Federal tax deduction can equal as much as the product of $1.80 per square foot (or $ 0.60 per square foot for each system {i.e. the Envelope, HVAC and the Lighting}) and the building’s floor area.

Analysis suggests that this makes energy improvements made in building with areas of 20,000 square feet or more quite attractive. Although, both larger and smaller building do qualify, and therefore the Deduction should be seriously considered wherever renovations touch on the Deduction’s areas of interest.

Each system has its system specific energy targets (at least until regulations are promulgated).

As for Lighting, the lighting power density must be reduced forty percent (40%) (or fifty percent (50%) in the case of warehouses). Also, if the new Lighting reduces its power density by twenty-five percent (25%) the Deduction is equal to $ 0.30 per square foot with the rate prorated for power density reductions between 25% and 40%.

The Deduction is allowed for both new construction and remodeling and these improvements must be placed in service between 2006 through 2013.

Note that this Federal tax incentive is a “deduction” rather than a “tax credit”, meaning that the cash benefit is calculated by multiplying the deduction times the tax rate. We can assist you to compute your estimate your tax savings.

Examples of Energy-Efficient Building Materials and Systems:

• Envelope – High-efficiency insulation in walls, ceilings and floors
• HVAC – Automatic thermostats and other monitoring equipment
• Lighting – Energy-efficient fixtures, controls and monitoring equipment
• HVAC – Ultra-efficient air conditioners and furnaces
• Envelope – High-performance glazing and other energy-efficient materials on the building envelope
• HVAC- Natural ventilation
• Lighting – Day-lighting
• HVAC – Improved fan efficiency

Claiming the Deduction:

• The building must meet energy and power costs reduction standards as detailed in ASHRAE Standard 90.1-2001; Energy Standard for Buildings Except Low-Rise Residential Buildings (effective April 2, 2003).
• An independent, qualified individual must verify and certify that the property installed satisfies specific energy efficiency requirements using IRS-approved software.

How Can H&M Help?

As with most governmental incentive programs, this Deduction provides many obstacles that frustrate taxpayers’ full utilization of it. H&M can assist you through:

• We can calculate the amount of the Deduction;
• We can effectively claim the Deduction on your federal income tax return; We can secure necessary government agency assignment where/if necessary;
• We can file amended tax returns to claim the Deduction;
• We can request necessary accounting method changes to permit claiming the Deduction;
• We provide necessary energy efficiency certifications through a network of technical specialists—
  • Review construction documents;
  • Make site visits; and
  • Hold discussions with building designers, project managers and related personnel.

To learn more about the Energy Efficient Commercial Building Deduction and how it could be applied to your business, contact Stephen C. Smith or your Holbrook & Manter representative. e have facilitated tax savings for a number of growth-minded clients.

The Deduction also provides tangential benefits in the form of rebates from utility providers such as American Electric Power and low interest financing sponsored by the Ohio Department of Development.

Regrettably, this deduction is used by only about ten percent (10%) of otherwise qualifying projects.  And, it is probably even less frequently considered in the cost/benefit analyses of most renovation projects.  Don’t have regrets; save money and taxes!

How Does the Deduction Work?

The Deduction can reward companies and building owners who make qualifying improvements to a building’s envelope (the “Envelope”), the HVAC/hot water systems (collectively, the “HVAC”), and the interior lighting systems (“Lighting”).  You should bear in mind that this Deduction is a source of ordinary income for recapture purposes on the disposition of depreciable personal and real property.

The technical standards for the Deduction are beyond the scope of this piece.   However, in general terms, if these building system improvements result in a fifty percent (50%) reduction in the building’s energy/power costs (when compared to a “reference building”) this Federal tax deduction can equal as much as the product of $1.80 per square foot (or $ 0.60 per square foot for each system {i.e. the Envelope, HVAC and the Lighting}) and the building’s floor area.

Analysis suggests that this makes energy improvements made in building with areas of 20,000 square feet or more quite attractive.   Although, both larger and smaller building do qualify, and therefore the Deduction should be seriously considered wherever renovations touch on the Deduction’s areas of interest.

Each system has its system specific energy targets (at least until regulations are promulgated).

As for Lighting, the lighting power density must be reduced forty percent (40%) (or fifty percent (50%) in the case of warehouses).  Also, if the new Lighting reduces its power density by twenty-five percent (25%) the Deduction is equal to $ 0.30 per square foot with the rate prorated for power density reductions between 25% and 40%.

The Deduction is allowed for both new construction and remodeling and these improvements must be placed in service between 2006 through 2013.

Note that this Federal tax incentive is a “deduction” rather than a “tax credit”, meaning that the cash benefit is calculated by multiplying the deduction times the tax rate.  We can assist you to compute your estimate your tax savings.

Examples of Energy-Efficient Building Materials and Systems:

• Envelope – High-efficiency insulation in walls, ceilings and floors
• HVAC – Automatic thermostats and other monitoring equipment
• Lighting – Energy-efficient fixtures, controls and monitoring equipment
• HVAC – Ultra-efficient air conditioners and furnaces
• Envelope – High-performance glazing and other energy-efficient materials on the building envelope
• HVAC- Natural ventilation
• Lighting – Day-lighting
• HVAC – Improved fan efficiency

Claiming the Deduction:

• The building must meet energy and power costs reduction standards as detailed in ASHRAE Standard 90.1-2001; Energy Standard for Buildings Except Low-Rise Residential Buildings (effective April 2, 2003).
• An independent, qualified individual must verify and certify that the property installed satisfies specific energy efficiency requirements using IRS-approved software.

How Can H&M Help?

As with most governmental incentive programs, this Deduction provides many obstacles that frustrate taxpayers’ full utilization of it.  H&M can assist you through:

• We can calculate the amount of the Deduction;
• We can effectively claim the Deduction on your federal income tax return; We can secure necessary government agency assignment where/if necessary;
• We can file amended tax returns to claim the Deduction;
• We can request necessary accounting method changes to permit claiming the Deduction;
• We provide necessary energy efficiency certifications through a network of technical specialists—
  • Review construction documents;
  • Make site visits; and
  • Hold discussions with building designers, project managers and related personnel.

To learn more about the Energy Efficient Commercial Building Deduction and how it could be applied to your business, contact Stephen C. Smith or your Holbrook & Manter representative.  We have facilitated tax savings for a number of growth-minded clients.

Currently, IC-DISCs can provide up to a 20 percent tax advantage on qualifying  export income.  And, IC-DISCs are not very difficult to set up and maintain.  If you export U.S.-made products, you should give an IC-DISC serious consideration.

IC-DISCs are essentially a “special purpose corporation” whose principal purpose avails exporters a statutorily mandated tax incentive by (1) not taxing the IC-DISC (2) allowing the related exporter to deduct its IC-DISC payments and (3) taxing IC-DISC owners at a 15% rate on distributions.

The tax savings/incentive can equal 20% if the exporter pays federal income taxes at the 35% and its deductible payments to the IC-DISC are distributed to its owners who are taxed at a 15%.  Obviously if tax changes affect the relationship between corporate rates and individual dividend rates this incentive may reduce or disappear.

 IC-DISC Requirements:

An IC-DISC is not required to (a) perform services, (b) hire employees or (c) have any tangible assets.   But IC-DISCs must maintain their own financial and accounting records, and must file a federal tax return.

The export company can be a C Corporation, S Corporation, LLC or partnership, and the IC-DISC shareholders can be individuals, corporations, trusts or a combination.  However, IC-DISCs can only be C Corporations.

At least 95 percent of the IC-DISC’s income and assets must be related to export activity, and the exported product must be comprised of at least 50 percent U.S. content.  However, there is an exception for architects and engineers who work on projects that will be constructed outside the U.S.

The other IC-DISC requirements include:

• It must be approved by the Internal Revenue Service.  The paperwork must be filed within 90 days of the start of the tax year.
• It must be incorporated in one of the 50 states or the District of Columbia, which means the IC-DISC, might have to pay state income tax on the commissions it receives from the export company.
• It must have only one class of stock with a par value of at least $2,500.

Operating as an IC-DISC:

Once the IC-DISC has been created and IRS approved, the export company can begin to see financial benefits, but not before.

The export company pays a commission to the IC-DISC equal to no more than the greatest of: (i) 4 percent of the gross receipts from all qualified export sales, (ii) 50 percent of net income from all qualified export sales or (iii) a commission acceptable under traditional related party pricing rules.

Other considerations:

It is worth noting that the shareholders of the IC-DISC do not need to match the shareholders of the parent company.  In certain estate-planning circumstances, it can be helpful to structure ownership of the IC-DISC different from the parent company.

IC-DISC shareholders are able to defer tax on commissions by paying a small interest charge at the T-bill rate, which recently has been less than 1 percent.

As with any tax incentive, there are complex regulations that you must always be aware of.  However at its core, an IC-DISC is a valuable boost for American companies that wish to compete on a global stage.

To learn more about IC-DISC and how it could be applied to your business, contact Stephen C. Smith or your Holbrook & Manter representative. We have facilitated tax savings for a number of growth-minded clients.

The President is lobbying to both expand and extend the “research and experimentation tax credit” (the “R&D Credit”).  A noble effort, but the irony is many qualified small businesses aren’t availing themselves of it.  Manufacturers, contractors, architects, engineers, software developers and other innovators are leaving millions, perhaps more than a billion, dollars on the table annually.  Similarly, use of the “research and development” deduction has been avoided due to its status as a tax preference under the alternative minimum tax, subject to elections beyond the scope of this piece.

Historical overview – The R&D Credit was a Reagan Administration initiative encouraging private sector innovation and keeping pace with foreign competitors.  The Bush Administration expanded the R&D Credit’s application to a wider range of businesses, and the Obama Administration has proposed both making it permanent as well as expanding its application.  The R&D Credit, although couched as a “temporary tax feature,” has been extended 14 times.  It expired at 2011’s end.

Even with this underutilization, $9 billion in R&D Credits were claimed in 2008 (the most recent tax year for which data is available).  Did your business participate? 

In 2008, agricultural companies claimed more than $5 million, real estate companies claimed more than $7 million, management companies claimed more than $60 million, wholesale and retail companies claimed $430 million, and transportation equipment manufacturers claimed more than $1 billion. 

Unfortunately, as a Bloomberg Government study concludes, large companies claim a disproportionate share R&D Credits because many small businesses either find it too difficult to file the IRS required information or are unaware they qualify for R&D Credits.

According to Bloomberg’s study, small businesses account for 40 percent of private-industry research but received only 23 percent of R&D Credits in recent years.  Bloomberg’s study found a few common reasons for businesses not taking full advantage of R&D Credits:

• They do not know they qualify for a R&D Credit;
• The R&D Credit formula is too complex and the required documentation is too difficult to obtain;
• They are worried about making a long-term R&D investment when the R&D Credit could expire.

Tax credits usually mean more to profitable companies, but as R&D Credits can be claimed for all open tax years (generally meaning the current year and the past open tax years) and those credits carry forward for up to 20 years, R&D Credits may be valuable even to companies currently operating at a loss.

Defining ‘R & D’

Time, money and other resources devoted to improving a product or process could result in a R&D Credit for your business.  If you devoted resources are directed at:

• Research which is technological in nature;
• The activity and your devoted resources are directed at a new or improved product or process;
• The activity and your devoted resources are directed at the discovery of information that is currently unknown;
• The activity and your devoted resources must evaluate alternatives.

Hence, developing a lighter or more flexible tool, designing a unique electrical system for a new building, testing new materials, applying for a patent or streamlining an internal process can deliver an R&D Credit to your business.

R&D Credits cover employee wages directly contributing to R&D, supplies and software used in R&D activity, and contracted R&D services. There are two alternative measures of the R&D Credits:

• 20 percent of R&D expenses above a “base amount” (based on a fixed base percentage and the company’s average annual gross receipts of the preceding 4 taxable year), or
• 14 percent of R&D expenses above 50% of the company’s average R&D expenditures over its previous three years (aka the simple measurement).

Frequently, small businesses find it challenging to segregate normal business expenses from those that result in R&D Credits.  R&D specialists can assist in that segregation process and often return R&D Credits far in excess of the specialist’s fees.

Proposed simplification to R& D Credits

The Obama Administration has proposed two revisions that (a) raises the simple R&D Credit measurement to 17 percent and (b) makes the R&D Credit permanent.

Regardless of the Obama Administration initiatives success, there are short-term savings and long-term implications which make current pursuit of R&D Credits for forward looking companies desirable.

To learn more about R&D Credits and how they may favorably impact your business, contact Stephen C. Smith, or your Holbrook & Manter representative before attempting to take full advantage of R&D Credits.  We facilitate R&D Credits for growth-minded clients.