Tax Strategies Can Bring Real Value To Your Organization


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Tax Strategies Can Bring Real Value To Your Organization

  2. 2. GETTING STARTEDTAX STRATEGIES CAN BRING REAL VALUE TO YOUR ORGANIZATION Today’s session begins at 2:00 Eastern / 11:00 Pacific To Join the Audio portion of the Event: 1 (866) 639-9991 (Toll-Free (US & Canada)) +1 (678) 302-3571 (International Dial-in (Toll)) Questions You can submit questions at any time to the “Q&A Group” through the chat feature located on the right of your webcast console. Presentation Slides You will receive a follow-up email with a link to download today’s presentation. The webinar archive will also be posted to 2 to 3 business days after the webinar. For Technical support, please contact: E-mail – Phone – (877) 480-4300 or *0 from the conference
  3. 3. INTRODUCTION Jerry Jonckheere National Tax Office Plante & Moran Nathan Buchalski Chuck Marchand Michael Merkel Bill HensonTax Solutions Group Tax Solutions Group State & Local Tax Group International Tax Services Plante & Moran Plante & Moran Plante & Moran Plante & Moran
  5. 5. PROGRAM OVERVIEW• GOAL – Provide incentive to invest in low-income communities• PROGRAM STRUCTURE – Federal government provides a subsidy to taxpayers who make qualifying investments – Form of subsidy = Federal Tax Credit • Federal Credit = 39% of investments made • Credit is taken over a 7-year period • Credit is subject to 100% recapture during the 7-year compliance period if program rules are not followed • Credits Provide 5.7% ROI (before any Project ROI) 1
  7. 7. BENEFITS TO TAX CREDIT INVESTOR• INVESTOR RECEIVES TAX CREDIT – An investor will receive a tax credits equal to 39% of the qualified investment (allocation) made in a Community Development Entity (CDE). – The tax credit is spread over a 7-year period. – 5% in each of the first 3 years (15%) – 6% in each of the next 4 years (24%) – Total equals 39% – Thus, for an investment of $10 million the total tax credit over 7 years would be $3.9 million. – Return on Investment = 5.68% from credits 3
  8. 8. PARTICIPANTS• CDFI FUND - COMMUNITY DEVELOPMENT FINANCIAL INSTITUTIONS FUND – Division of U.S. Department of the Treasury – Jointly administers NMTC program with IRS – Responsible for: • Certifying Community Development Entities (or “CDEs”) • Allocating New Markets Tax Credit awards • Monitoring CDE Compliance• INTERNAL REVENUE SERVICE – IRS is responsible for issuing tax-related regulations and guidance. 4
  9. 9. PARTICIPANTS• COMMUNITY DEVELOPMENT ENTITY (“CDE”) – Entity with a primary mission of serving low-income communities (can be for-profit or not-for-profit) – CDEs must be certified by the CDFI Fund – CDEs are awarded NMTCs which they pass through the tax credit to investors • A limited amount NMTCs are allocated to CDEs annually • The competition for NMTCs is highly competitive 5
  10. 10. PARTICIPANTS• QUALIFIED ACTIVE LOW-INCOME COMMUNITY BUSINESS (“QALICB”) – A business that meets the qualification requirements• TAX CREDIT INVESTOR – A taxpayer that makes a qualified equity investment (“QEI”) in a CDE• ECONOMIC LENDER – A lender that works with a Tax Credit Investor to form an Investment Fund. The Tax Credit investor leverages his/her investment and is allocated all of the NMTCs. 6
  11. 11. WHAT COMMUNITIES QUALIFY AS LOW INCOME?• CRITERIA USED – Statutory Criteria – Poverty rate and median income in defined census tracts – Contractual Criteria – Higher standards than the statutory criteria may be included in a CDE’s “Allocation Agreements” with the CDFI• DETERMINING CENSUS TRACT ELIGIBILITY – CDFI Fund website provides eligibility based on the location’s address 7
  12. 12. QUALIFIED ACTIVE LOW-INCOME COMMUNITY BUSINESS• ELIGIBLE BUSINESSES – Any trade or business is eligible • Except “sin” businesses – Non-profit entities are eligible – Rental of improved nonresidential real estate is eligible • Mixed use is okay if not more than 80% of the revenue is from residential rental income• RESIDENCY OF EMPLOYEES – There is no requirement that the employees be residents of the low-income community 8
  13. 13. EXCLUDED BUSINESSES• “SIN” BUSINESSES A qualified business does not include any trade or business consisting of the “operation” of any: – Country club – Massage parlor – Hot tub facility – Suntan facility – Racetrack or other gambling facility – Any store whose principal business is the sale of alcoholic beverages for consumption off premises – Private or commercial golf course (Yes, golf courses…) 9
  14. 14. COSTS RELATED TO THE INVESTMENT• TRANSACTION COSTS – Transaction complexity depends on • The size and complexity of the underlying business investment • Any additional requirements negotiated in the Allocation Agreement • Number of outside investors or provider of loans – Each investor will generally have their own advisors – Generally, an investment of at least $1 million is necessary 10
  15. 15. RECAPTURE RISKS• PENALTY FOR RECAPTURE If there is a recapture event at any time during the 7 years immediately after a QEI is made, then: – The entire amount of the NMTCs claimed by the investor must be repaid to the IRS with interest – The investor will not be able to claim any remaining NMTCs with respect to that investment 11
  17. 17. INVESTMENT INCENTIVES• 37 OF 51 JURISDICTIONS HAVE AT LEAST ONE FORM OF INVESTMENT CREDIT – Note that 3 States do not have an income or franchise tax • Therefore, only 11 states with an income/franchise tax do not provide some level of investment incentives – In general: • The credits offset income tax liability – Unique to each state: • Differing eligibility requirements • Differing calculations 13
  18. 18. INVESTMENT INCENTIVES • EXAMPLE OF CREDIT FOR CAPITAL ACQUISITIONS – Michigan • Widely available to all businesses • Low rate – equal to business tax rate • Credit claimed on normally filed tax return – Arkansas • Available to all business • Minimum thresholds apply • Businesses must apply to claim credit – Georgia • Available only to manufacturers and telecommunications – Recapture when certain requirements not met 14
  20. 20. DPAD OVERVIEW• DOMESTIC PRODUCTION ACTIVITIES DEDUCTIONS (DPAD) – The deduction was started in 2005 as an incentive to manufacturers and “producers” – Deduction initially was a deduction equal to 3% of Qualified Production Activities Income (QPAI) • 2005-2007 – 3% • 2008-2009 – 6% • 2010 forward - 9% 16
  21. 21. DPAD - QUALIFICATIONS• MANUFACTURING & PRODUCING & GROWING & EXTRACTING (MPGE) – Selling, leasing, or licensing items that have been manufactured in the U.S. – Construction services in the U.S., including building and renovation of residential and commercial properties – Engineering and architectural services relating to a U.S.- based construction project – Software development in the U.S., including the development of video games – Extraction of minerals in the U.S. – Growing of agricultural products or livestock 17
  22. 22. DPAD - CALCULATION• COMPUTED ON AN ITEM-BY-ITEM BASIS – Company must review its trade or businesses on an item-by- item basis to determine which items qualify • A company that manufactures products and distributes its own and third party products would only claim a DPAD on its manufacturing operations and distribution of its products • A company that partially manufactures its products in the U.S. and outside of the U.S. must determine the value attached to each location.• DPAD DEDUCTION CALCULATION – Qualified production activities gross receipts minus – Qualified production activities expenses equals – Qualified Production Activities Income (QPAI) – QPAI multiplied by the QPA deduction amount of 9% is tentative deduction – Reduces effective tax rate on qualifying activities by as much as 3.15% 18
  23. 23. TIER I AUDIT EXAMINATION ISSUE• IRS “Tier I Issues” are issues that the IRS has identified as issues that must be reviewed upon audit. – The IRS has specialists for each “Tier I Issue”.• Identification as a Tier I Issue increases the need for proper documentation. – The IRS does not seem to be specifically targeting taxpayers with DPAD deductions. 19
  24. 24. DOCUMENTATION ISSUES• DPAD DEDUCTION IS BASED ON PROFITS – Not based on gross sales – Based on profits of qualifying activities – Documentation must: • Show how qualifying activities were determined • How expenses are allocated to qualifying and non-qualifying activities• REGULATIONS REQUIRE SPECIFIC METHODS FOR EXPENSE ALLOCATIONS – Simplified methods exist for small taxpayers • <$5 million in sales • <$100 million in sales – Cost accounting detail is generally required to support allocations 20
  25. 25. DOCUMENTATION ISSUES• Small and mid-sized companies are required to have the same documentation as larger companies even though their deduction may be smaller. – Simplified expense allocations are available for companies with <$5 million in sales – Simplified expense allocations are available for companies with <$100 million in sales• Cost accounting may not always be available.• Each taxpayer must review his/her own accounting systems and particular facts to determine appropriateness of documentation. 23
  26. 26. STATISTICAL SAMPLING METHODS• Rev. Proc. 2007-35 provides guidance for determining when statistical sampling may be used for purposes of the DPAD deduction and establishes acceptable statistical sampling methods.• Statistical sampling provides audit protection for complete item-by-item testing.• The statistical results are one-sided in favor of the IRS. – This lowers the deduction for the taxpayer. 24
  27. 27. REV. PROC. 2007-35• STATISTICAL SAMPLING IS CONSIDERED A REASONABLE METHOD TO: – Allocate Gross Receipts between DPGR and non-DPGR – Allocate Cost of Goods Sold between DPGR and non-DPGR – Allocate deductions between DPGR and non-DPGR 25
  28. 28. WHEN TO USE STATISTICAL SAMPLING• According to Rev. Proc. 2007-35, all facts and circumstances must be considered, including: – Time required to analyze large volumes of data – Cost of analyzing data – Existence of verifiable information – Availability of more accurate information• The sampling method must be conducted under normal sampling guidelines and done in an unbiased scientific manner.• A written sample plan is required prior to the execution of a sample. 26
  29. 29. WRITTEN STATISTICAL SAMPLING PLAN REQUIREMENTS• Objective of the plan including a description of the value for estimation and the applicable taxable year• Population definition and reconciliation of population to the tax return• Definition of the sampling frame and the sample unit• Source of the random numbers, starting points, and method of selection• Method to associate random numbers to the frame• Steps to ensure that the serialization of the frame is independent of the drawing of random numbers• Steps for evaluating the sampling unit• Estimator that was used for appraising the sample 27
  30. 30. NON-STATISTICAL METHODS• Document qualifying and non-qualifying activities – Analysis of business units• Create sampling methodology based on activities and information available from taxpayer• Extrapolate sample results against entire business 28
  31. 31. RECENT AUDIT RESULTS• IRS audits have eliminated the entire deduction when documentation has not been provided.• Example : C corporation with $20m in gross receipts, $600k qualifying income. Corporation was a manufacturing company. Deduction was eliminated due to no documentation.• Example: S corporation sold over 5,000 items. It possessed no electronic cost accounting information. Entire deduction was eliminated upon audit. 21
  32. 32. STUDY BENEFITS - CASE STUDY• Taxpayer manufacturers some of the products it sells and purchases other products from third parties for resale.• A review of taxpayer’s activities determined that 93% of its taxable income qualified for the DPAD deduction though only 83% of its gross receipts qualified as domestic production activities. The review showed that the taxpayer was more profitable on its manufacturing activities than its resale activities.• The review provided the company with documentation that supported the deduction. 22
  33. 33. ADVICE FOR SMALL AND MID-SIZED BUSINESSES• Audit experience has shown that documentation on an item-by-item basis is required to sustain a DPAD deduction.• Non-statistical sampling has satisfied the first level of scrutiny in most audit situations.• Samples can range in size but should be appropriate based on size of company. – Small customized samples have been as small as 20 items – Large samples have been 40 to 50 items• The IRS has not (yet) questioned non-statistical sampling if properly documented. 29
  34. 34. TAKEAWAY• DPAD IS STILL RELATIVELY NEW – Agents do not have a lot of experience (yet).• AUDITS HAVE OFTEN FOCUSED ON THE FOLLOWING QUESTIONS: – Does taxpayer have MPGE qualifying activities? – Has taxpayer followed documentation requirements? 30
  36. 36. IC-DISC• DOMESTIC INTERNATIONAL SALES CORPORATION (“DISC”) – Provides a significant tax benefit for • U.S. manufacturing companies that export • U.S. distribution companies that export U.S. manufactured goods • Architectural and engineering firms overseeing non-U.S. construction projects – Oldest tax benefit for exporters • Since 1972 • The “Godfather” of export incentives 32
  37. 37. IC-DISC• DISC – HOW IT WORKS – DISC is a separate legal entity – U.S. company pays “commission” to DISC based on its profits from the sale of qualifying export property • Commission is deducted at corporate rates (34-35%) or at the marginal rate of the shareholders of a pass-through entity • DISC is a ‘flow through’ entity and does not pay tax on the commission income – DISC pays dividend to shareholder • The dividend is treated as a qualifying dividend under current law and is taxed at 15% 33
  38. 38. IC-DISC• HOW IS THE COMMISSION CALCULATED? – 50% of combined taxable income • Combined taxable income is like earnings before tax. Up to 50% of the CTI for *qualified receipts* from *export property* can be paid as a commission – 4% of gross receipts • Limited to CTI – Any other reasonable method 34
  39. 39. IC-DISC• EXAMPLE – U.S. Co sells $1,000,000 in export property to Canada • CTI = $50,000 – U.S. Co pays a commission of $40,000 to DISC • $40,000 = $1,000,000 * 4% – U.S. Co gets tax benefit of $14,000 • $40,000 deduction * 35% tax rate – Shareholder pays tax of $6,000 • $40,000 dividend * 15% Qualified Dividend Rate – Net benefit $8,000 ($14,000 - $6,000) 35
  40. 40. IC-DISC• DISCS ARE (RELATIVELY) EASY TO SET UP AND MAINTAIN – Corporation must be set up – DISC status elected – Commission agreement should be signed – Annual computation and tax return • Form 1120-IC-DISC 36
  42. 42. THE “GENERAL” R&D CREDIT• GENERAL CREDIT FOR INCREASING RESEARCH ACTIVITIES – QREs – Qualified Research Expenses • Wages • Supplies • Contract Expenses – Fixed Base Percentage • 1984-1988 • Start-up method – Credit is equal to 6.5% of • Current Year QREs • Less: fixed base percentage times average gross receipts from prior 4 years • Hence, the credit is for increasing your current research activities over the base period amount 38
  43. 43. ALTERNATIVE SIMPLIFIED CREDIT• ALTERNATIVE SIMPLIFIED CREDIT – QREs – Qualified Research Expenses • Wages • Supplies • Contract Expenses – Credit is equal to 4.55% of • Current year QREs • Less: based determined from prior 3 years – Benefit is usually lower than the general credit 39
  44. 44. CURRENT STATUS OF CREDIT – The R&D Credits has not been reenacted by Congress for periods after 12/31/2009 – The R&D Credit has expired and extended 13 times in the past – The R&D Credit has lapsed only 12 months since 1981 – Five Major Modifications since 1981 – Both political parties want the credit passed – the only question is how and when • Permanent Extension is too expensive 40
  45. 45. CURRENT DEVELOPMENTS• RESEARCH AND DEVELOPMENT TAX CREDIT (R&D) – R&D continues to change over time • Expirations, reenactments, changes to calculations – Taxpayer – IRS controversies are leading to judicial involvement in deciding issues – IRS audit activity continues to increase • Tier I Issue • Automatic audits on amended returns • ‘Nexus’ between qualifying expense and qualifying activity 41
  46. 46. TG MISSOURI• TG Missouri v. Commissioner, 133 T.C. No 13 (2009)• TG Missouri was an automotive industry injection-molder• TG Missouri contracted with third-parties to test and modify the third-party’s production molds• TG Missouri did not take depreciation on the molds as they did not own the molds.• TG Missouri claimed the production mold costs as a supply qualifying as a Qualified Research Expense• The Tax Court agreed that the production mold costs were qualifying expenses on the sole basis that they were not able to be depreciated by TG Missouri• However… 42
  47. 47. TG MISSOURI• Due to concessions by the IRS, the Tax Court did not address: – Were the production mold costs used primarily in the conduct of qualified research? – Were the production mold costs incurred after commercial production began? – Were the production mold costs related to a qualifying activity? 43
  48. 48. APPLICATION OF TG MISSOURI• This case could increase the R&D Credit for companies in the following industries: – Automotive OEM suppliers – Manufacturers of production tooling and component parts – Consumer/Industrial product companies• The case could have limited applicability if: – IRS appeals (and wins) the Tax Court decision – IRS does not acquiesce in the case – this would indicate that the IRS would challenge taxpayers using the case with dissimilar facts – Not applied to situations with an identical fact pattern 44
  49. 49. UNION CARBIDE V. COMMISSIONER• Union Carbide v. Commissioner, T.C. Memo. 2009-50• Chemical manufacturer tested manufacturing process improvements to improve the plant efficiency.• Research was undertaken to determine if the process improvements met the manufacturer’s basic functional and economic needs.• Testing was undertaken through a typical production run at the production facility; and the resulting products produced (olefins) were sold in the ordinary course of business.• Raw materials used in these production runs were taken as qualifying supplies. 45
  50. 50. UNION CARBIDE V. COMMISSIONER• The Tax Court adopted the “primarily” standard• The test used was whether the raw material expenses were incurred primarily as a result of: – Research related to the development of a new or improved manufacturing process, or – Producing the product• Statute does not state expressly that supplies be used “solely” in qualified research – “Primarily” is, therefore, a judicial standard• The Tax Court agreed that the raw materials were Qualified Research Expenses 46
  52. 52. STATE RESEARCH & DEVELOPMENT CREDIT• GENERAL RULES – Like federal credits, state credits are designed to encourage basic research – Most follow I.R.C. Section 41 to define R&D costs• CALCULATION – Two general methods • Based on increase in research and development expenditures, or • Based on a percentage of the federal credit 48
  53. 53. RESEARCH & DEVELOPMENT CREDIT• COMMON VARIANCES FROM FEDERAL RULES BY STATES – State credit based only on research occurring in their state – Definition of Qualified Research Expenditures can be different 49
  54. 54. RESEARCH AND DEVELOPMENT TAX CREDIT [6] California Illinois MichiganLimit on Expenditures In CA only In IL only  In MI onlyQualifying expenditures Fed in 2004 Similar to Fed Same as Fed [1] [2] Multiple Methods  Excess over prior 3 year  100% of Current year MI Calculation of expenses for credit available average expense [3]Carry forward Unlimited 5 years NoneRate of Credit Varies 6.50% 1.90%Limit on offset of liability 50% 100% 65% [4] [5]Do you have to claim the federal credit to be eligible? No No No[1] California expenditures decoupled with federal definition starting with changes made by the Energy Tax Incentives Act of 2005 and going forward.[2] California does not adopt federal provisions that: Increase the credit for amounts paid to eligible small businesses, universities or federal labs Allow a credit for amounts paid to a research consortium for energy research Increase the rates used to compute the alternative incremental credit[3] Allow for fixed base % calculation or an Alternative credit computation. If Alternative credit is elected, it is binding until election is revoked with FTB consent.[4] For 2008 & 2009, CA limits the credit to 50% of a taxpayers liability (unless business income  is less than $500,000)[5] MI 65% limit includes deduction for Compensation Credit and ITC credit.[6] No longer allowed for tax years beginning on or after July 30, 2009 50
  56. 56. CANADIAN SR&ED CREDIT• CANADIAN SCIENTIFIC RESEARCH & EXPERIMENTAL DEVELOPMENT CREDIT (SR&ED) – Credit for qualifying SR&ED activities that take place in Canada • Plus certain non-Canadian support costs – Credits is in addition to the deduction of SR&ED expenses – SR&ED machinery & equipment can be deducted – Small companies (taxable income <C$500,000) get a 35% credit • Larger Companies – 20% – Most provinces also have their own credits 52
  58. 58. JOB INCENTIVES• 41 STATES + D.C. HAVE JOB RELATED INCENTIVES – Credits are normally applied against income/franchise taxes – Credits are generally based on a minimum level of job creation – Wage targets may be applied – Credits may be available (or increased) for “targeted” employees – Credits may be based on retention of or growth in jobs 54
  59. 59. JOB INCENTIVES• OHIO NEW JOBS CREDIT – Originally applied against OH Franchise Tax, now applied to the Commercial Activities Tax (“CAT”) – Taxpayer must apply to the “Tax Credit Authority” – Project must meet the following criteria: • Increase payroll and income tax revenue • Project must be “economically sound” and will benefit “the people of Ohio” • The tax credit is a “major factor” in keeping or moving the project to Ohio – Calculation: • Percentage of income tax withholdings • May not exceed 100% of income tax withheld from new employees – REFUNDABLE! – Period – up to 15 years 55
  60. 60. STATE & LOCAL CREDITS & INCENTIVES• PROPERTY TAX INCENTIVE EXAMPLE – Michigan–industrial property tax abatement • Taxpayer may receive a partial abatement of real and personal property taxes • The abatement can be for periods up to 12 years • Property must be in a tax incentive district (may be formed by local authorities) • IFT application must be completed • Public hearing(s) must be held and attended for local approval • Agreement must be signed with municipality • Available only to manufacturer with “new” investments 56
  61. 61. STATE & LOCAL CREDITS & INCENTIVES• SALES TAX INCENTIVES – Manufacturing machinery and equipment • California: No exemption, subject to tax upon purchase for use • Michigan: 100% exempt from tax if used for industrial processing • Some states tax manufacturing machinery at a reduced rate• RENEWABLE ENERGY INCENTIVES • June 8th webinar from 10:00 to 11:00 EDT • All 50 States as well as D.C., Puerto Rico and the Virgin Islands have adopted Renewable Energy Incentives – Wind Power – Solar Power – Other (Fuel Cells, Biomass, Renewable fuels, etc.) 57
  63. 63. FOR MORE INFORMATION Jerry Jonckheere National Tax Office 616.643.4044 Michael Merkel Nathan Buchalski State & Local Tax Group Tax Solutions Group 248.223.3264 734.302.6960 Chuck Marchand Bill Henson Tax Solutions Group International Tax Services 734.302.6946 248.375.7311 Bill