SALT & Federal and State R&D Updates
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SALT & Federal and State R&D Updates

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Delivered to Portland Chapter of Tax Executives

Delivered to Portland Chapter of Tax Executives

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SALT & Federal and State R&D Updates SALT & Federal and State R&D Updates Presentation Transcript

  • State and Local Tax Updates Presenters: Rob O’Neill, CPA – Partner Dan Lapour, J.D. – Senior Manager 1
  • The material appearing in this presentation is for informational purposes only and should not be construed as advice of any kind, including, without limitation, legal, accounting, or investment advice. This information is not intended to create, and receipt does not constitute, a legal relationship, including, but not limited to, an accountant-client relationship. Although this information may have been prepared by professionals, it should not be used as a substitute for professional services. If legal, accounting, investment, or other professional advice is required, the services of a professional should be sought. 2
  • AGENDA • • • • • • • Oregon California Washington Texas National State Tax Trends Voluntary Disclosure Agreements Parting Thoughts 3
  • OREGON UPDATE 4
  • OREGON REGULAR LEGISLATIVE SESSION • A little bit of a no tax news session • A few bills passed that impacted business & individual taxation • What didn’t pass is more interesting o o o o o No apportionment bill to adopt market sourcing No PERS reform No significant tax increases No BETC or other tax credit overhaul bill No action taken on minimum tax • Special session was called to deal with PERS, school funding and tax reform 5
  • TAX HAVEN LEGISLATION - HB 2460 • • Signed into law August 1, 2013; Effective January 1, 2014 To determine Oregon taxable income, income/loss from a member of a unitary group is included if it is incorporated in one of the following “tax haven” jurisdictions: o Andorra, Anguilla, Antigua and Barbuda, Aruba, the Bahamas, Bahrain, Barbados, Belize, Bermuda, the British Virgin Islands, the Cayman Islands, the Cook Islands, Cyprus, Dominica, Gibraltar, Grenada, Guernsey-Sark-Alderney, the Isle of Man, Jersey, Liberia, Liechtenstein, Luxembourg, Malta, the Marshall Islands, Mauritius, Monaco, Montserrat, Nauru, the Netherlands, Antilles, Niue, Samoa, San Marino, Seychelles, St. Kitts and Nevis, St. Lucia, St. Vincent and the Grenadines, the Turks and Caicos Islands, the U.S. Virgin Islands and Vanuatu. • • • • Instructs DOR to make rules to determine income/loss for a corporation that is a member of a unitary group and not otherwise required to file a consolidated federal return Interesting that Oregon would include income of foreign businesses when it is a water’s edge state Other states such as Montana, Alaska, West Virginia and District of Columbia have also adopted similar laws Watch out if you have a foreign operating subsidiary or captive 6
  • OREGON NEW MARKETS TAX CREDIT (NMTC) • HB 2763 • Amount of Qualified Equity Investment (QEI) increased from $4 million to $8 million • This program piggyback’s off the federal NMTC program • NMTC can now be applied to Oregon Insurance Excise Tax liability of foreign insurance companies without triggering the retaliatory tax • For QEI made after January 1, 2014, each annual credit may be carried forward for 5 years • Starting to see some companies using OR NMTC to finance energy projects 7
  • SPECIAL SESSION 2013 – HB 3601 • Passed October 2, 2013 as part of the “grand bargain” during the special session • Effective date of bill is January 1, 2014 • Bill applies to various tax years depending on specific provisions • Makes significant personal and corporate tax changes 8
  • THE GRAND BARGAIN - HB 3601 Corporate Tax Rate Increase • Applies to tax years beginning on or after 1/1/13 o 6.6% of the first $1 million of Oregon apportioned income (previously $10 million) o 7.6% of Oregon apportioned income thereafter Personal Exemption Credit Limited • Not applicable to High Income Tax Payers for tax years beginning 1/1/13 • Eliminated for joint return filers, surviving spouses, and heads of households when gross income exceeds $200,000 • Eliminated for single filers, or joint filers filing separate returns when income exceeds $100,000 9
  • HB 3601: IC-DISC TAX REGIME • IC-DISCs previously were taxed in the same manner as any other corporations in Oregon, however transactions between related parties where not respected (eliminated) resulting in an add back to the commission paying entity • New Law Provides Special Taxation of IC-DISCs: o IC-DISCs formed on or before January 1, 2014 are exempt from the corporate minimum tax (not the case before); o A 2.5% tax is imposed on any commission received by an IC-DISC (previously taxed at regular rates); o A deduction is allowed for commission payments made to an ICDISC formed on or before January 1, 2014 (previously eliminated); o A subtraction from federal taxable income is allowed for the amount of any dividend received from an IC-DISC (no change here); and o IC-DISCs formed after January 1, 2014 apparently taxed under old law 10
  • HB 3601: SMALL BUSINESS TAX CUT • For tax years beginning on or after January 1, 2015, a marginal tax rate structure is used for taxpayers receiving non-passive flow-through income from SCorps, partnerships and LLCs • To qualify: 1. 2. 3. The taxpayer must materially participate in the day-to-day operations of the trade or business; The entity must employ at least one person who is not a owner, member or limited partner; and The employee(s) in (2) must perform 1,200 aggregate hours of work in Oregon. For this purpose, only the hours worked by employees working at least 30 hours in any given week are aggregated 11
  • HB 3601: SMALL BUSINESS TAX CUT, CONT’D If the taxpayer meets the requirements, then nonpassive flow-through income from the S-Corp, partnership, or LLC is taxed at the following rates: Income greater than: But not greater than: Tax rate: --- $250,000 7% $250,000 $500,000 7.2% $500,000 $1 million 7.6% $1 million $2.5 million 8% $2.5 million $5 million 9% $5 million --- 9.9% 12
  • HB 3601: SMALL BUSINESS TAX CUT, CONT’D • A taxpayer may elect to be taxed at the normal rates, but the election is irrevocable and must be made on their original return • A taxpayer who used the marginal rates may not join in the filing of composite return • It is unclear whether or not the filing of a composite return is going to be deemed an election 13
  • CON-WAY, INC. & AFFILIATES V. DEPARTMENT OF REVENUE • Oregon Supreme Court held that Business Energy Tax Credits may be used against the corporation minimum tax • The DOR is interpreting this to apply to most other credits, as well as including the R&D credit • You may be able to get a refund and apply your credits to the minimum tax by filing an amended return • Credits may be used to offset minimum tax in future years • DOR is now processing refund claims (guidance available) • Amended returns are required if a protective claim letter was filed before the decision 14
  • AT&T V. DEPARTMENT OF REVENUE • Oregon Tax Court adopted a “transactional” approach of apportioning sales other than sales of tangible personal property. Every transaction of a business is analyzed to determine direct costs attributable to each state o Massachusetts, in contrast, has used an “operational” approach, where the business activity is views not as a series of transactions, but as a singular operation • The sales factor only includes “direct costs” – those that are only incurred because the revenue producing transaction or activity occurred. In other words, the court adopted a “but for” approach to costs • Oregon apportionment for service-based companies may be affected by this decision • We are seeing the ODOR use AT&T against out-of-state taxpayers • We are beginning to use AT&T to benefit in-state taxpayers 15
  • HEALTH NET, INC. V. DEPARTMENT OF REVENUE • Similar to The Gillette Co. v. Franchise Tax Board in California’s Court of Appeals o Issue is whether a taxpayer may elect to apportion income under the Multistate Tax Compact in lieu of the state specific apportionment provisions (e.g., single sales factor) o CA COA held that California could not enact a statute that repealed the provisions of the MTC without completely withdrawing from the Compact. They subsequently withdrew from the MTC compact • Currently under advisement in the Oregon Tax Court and referred to the Regular Division • Taxpayers may file a protective claim with the DOR pending the result of the Health Net decision • In response to this case, Oregon has withdrawn from the MTC compact and reinstated it without the evenly weighted apportionment formula 16
  • OREGON ENTERPRISE ZONES • Sponsored by municipal or tribal governments, Oregon has 50 rural and 13 urban EZs • Qualifying businesses receive a three year, up to five year property tax exemption for new buildings, machinery and equipment • Additionally, a construction-in-process exemption may apply for up to two years prior to the property being placed in service 17
  • E-COMMERCE OVERLAY TO ENTERPRISE ZONES • Several of Oregon’s 60+ EZs have received special status to further encourage electronic commerce (“E-Commerce”) • Current E-Commerce Zones include: Bend, East Portland, Greater Redmond, Hillsboro, Jackson County, Medford, Portland, Roberts Creek, Rogue, Salem and City of North Plains • The most significant feature is that a qualifying business may receive a credit against the taxpayer’s (or shareholder’s) annual state income or corporate tax liability up to $2 million per year • Credit equals 25% of the investment cost made in capital assets used in e-commerce operations inside the EZ • These incentives are in addition to the property tax incentives of the standard EZ program • We are seeing very poor compliance with companies taking advantage of the benefits of this incentive 18
  • RURAL RENEWABLE ENERGY DEVELOPMENT PROGRAM (“RRED”) • The RRED program provides ad valorem property tax exemption for a period of 3 to 5 years for certain renewable energy projects that meet program requirements • HB 2981 created some exceptions to these requirements when: o The governing body of zone sponsor adopts a resolution waiving employment requirements; and o A $5 million investment is made • RRED zones include, among others: Clackamas, Crook, Harney, Jefferson, Klamath, Lake, Linn, Malheur, Polk, Sherman, Union and Wasco Counties 19
  • OREGON PROPERTY TAX – LEGISLATIVE UPDATE • During the 2013 Legislative Session the Legislature o Extended the food processing equipment exemption  Applications and applicable fee due by December 31, 2013  Refund available if tax already paid o Property tax refund opportunity  Transmission property, leased to the Bonneville Power Administration (“BPA”), on US owned land, subject to a bargain purchase by the BPA at the end of the lease  Refund claims are due by December 6, 2013  Can go back to 2008 tax year 20
  • OREGON TRANSFERABLE CREDIT UPDATE • Business Oregon Tax Credit (“BETC”) – program was partially sunset 12/31/12 and will be officially sunset 7/1/2014. Many projects are still being completed that will generate credits • Credits can be transferred for 24 months after their final certificate has been issued • Time is running out to purchase BETC. Can be purchased for 73.6 cents on the $1 (only a couple of 67 cent BETC are out there) • Biomass Tax Credit – the program is still in place through 12/31/2017. Department of Energy continues to develop policy to reduce dollar size of the program • Credits can be purchased for 90 cents on the $1 and used immediately • Film Credit/Renewable Energy Grant Credit – Both credits are transferred through the auction process. Bids open at 95 cents. Opportunity for individuals to reduce federal AMT 21
  • OTHER STATE TRANSFERABLE CREDITS • Most active states for transferable credits offered by Moss Adams are: o Alaska, Connecticut, Louisiana, Oklahoma, Oregon, and Pennsylvania • Other available states are: o Arkansas, Florida, Illinois, Iowa, Massachusetts, and West Virginia 22
  • WHY PURCHASE TRANSFERABLE CREDITS? • Offset taxes and reduce your total income/franchise/premiums tax liability • Lower your effective tax rate • Offset trapped capital losses with gain on discount • Support various industries • Diversify your investment portfolio 23
  • MOSS ADAMS TAX CREDIT EXCHANGE • Moss Adams is planning a launch of a new online tax credit exchange platform located at: o www.theoix.com/mossadams • Only state certified credits are listed • Approved members can: o List credits for sale and set offer price and terms o Buy credits listed, bid on credits, or post nonbinding indication of demand 24
  • CALIFORNIA UPDATE 25
  • ENTERPRISE ZONE PROGRAM CHANGES • Assembly Bill 93 (signed into law 7/11/13) places strict hiring requirements on the reformed program • Sales tax credit is repealed and replaced by a partial sales and use tax exemption; old credit can still apply for items PIS during 2014 • Hiring Credit will be limited to companies that have a net increase in full-time employees who are paid between $12 and $28 an hour • Hiring Credit only available to employees that are a member of one of the following targeted groups: long-term unemployed, certain veterans, Federal EIC recipients, ex-offenders and welfare recipients o Will be unavailable to retail, food service, and other specified industries o Existing hiring credit will be available for qualified employees hired before December 31, 2013 • New incentives available January 2014. After 2013, any unused credit carry-forwards will be limited to 10 years • Companies that have not done a study should complete a study. Employees hired by 12/31/13 can be vouchered through 12/31/14 26
  • MANUFACTURING AND RESEARCH & DEVELOPMENT PARTIAL SALES TAX EXEMPTION Effective July 1, 2014 (signed into law by Governor Brown as part of Assembly Bill 93 and Senate Bill 90) o Applies to both sales and leases of qualifying property o Expires on July 1, 2022, unless otherwise extended o Partially tax exempt from California's sales and use tax o Saving $41.88 for every $1,000 in purchases of qualifying property  State general fund portion of the sales and use tax (4.188%) o Tax-exempt property could include:  machinery and equipment, including component parts  equipment and devices used or required to operate, control, regulate, or maintain the machinery  pollution control items  certain special purpose buildings and foundations 27
  • MANUFACTURING AND RESEARCH & DEVELOPMENT PARTIAL SALES TAX EXEMPTION • • • Must be used 50 percent or more in one of the following activities: o Manufacturing, processing, refining, fabricating, or recycling tangible personal property o Researching and developing o Maintaining, repairing, measuring, or testing any qualified property There is a $200 million exemption limit per person on purchases of qualified property in any calendar year The exemption is available only to businesses classified under 2012 NAICS o Codes 3111–3399 (manufacturing), o Code 541711 (biotech research and development), and o Code 541712 (physical, engineering, and life sciences R&D) 28
  • CALIFORNIA PERSONAL INCOME TAX INCREASES • Nov. 6, 2012 passage of Prop 30 increased personal income tax rates • They applied retroactively to 2012 • Increase is temporary for next seven years 29
  • CALIFORNIA - MARKET SOURCING • For taxable years beginning on or after January 1, 2013, sales, other than sales of tangible personal property, are sourced to California using a marketbased approach • For taxable years between 2010 and 2012, market sourcing is used if the taxpayer elects to have a singlefactor sales formula • In general, sales from services are assigned to California to the extent that the purchaser of the service receives the benefit of the service in California o Sales of intangibles are sourced to California to the extent the property is used in California 30
  • CALIFORNIA – ECONOMIC NEXUS RECENT EVENT • • • • • • California adopted an economic nexus standard for tax years beginning January 1, 2011 Nexus deemed to be created when more than one of the following exists: o CA sales exceed the lesser of $500K or 25% of total o CA property exceeds the lesser of $50K or 25% of total o CA payroll exceeds the lesser of $50K or 25% of total P.L. 86-272 still applies with exception of the California $800 minimum tax Throwback rule: Sales of TPP are included in the numerator of the California sales factor if the TPP is shipped from an office, store, warehouse, factory, or other place of storage in California to another state if the selling taxpayer is not taxable in the state of the purchaser In CCR 2012-03 (8/28/12), the FTB applied the new economic nexus standard, the Finnegan rule, and market-based sourcing to negate the throwback rule holding: o A taxpayer does not have to throw back TPP sales where it has more than $500,000 of sales in a foreign jurisdiction; or o Domestic tangible personal property sales when a member of its California unitary group has more than $500,000 of sales (including sales other than tangible personal property) in the destination state Provides an opportunity to create “no-where” income 31
  • WASHINGTON UPDATE 32
  • WASHINGTON – MARKET BASED SOURCING • Effective 6/1/2010, Washington adopted market-based sourcing rules for non-tangible receipts for purposes of the B&O tax • The B&O tax apportionment is calculated based solely on a “receipts factor” • Receipts are attributed to the state based primarily on where the customer received the benefit of the service • We continue to see a lot of audit and refund opportunity around this area • There are specific rules for determining where the benefit is received in certain industries 33
  • WASHINGTON B&O TAX: ECONOMIC NEXUS • • • • • • • • Economic nexus rules adopted in 2010: o Property: Average value exceeding $50,000; o Payroll: Exceeding $50,000; o Sales: Exceeding $250,000; or o At least 25% of worldwide property, payroll, or sales Business does not need to have physical presence to be subject to B&O tax Applies to businesses that provide services, loan interest or fees, and royalties Companies selling services may need to review their sourcing methodology Physical nexus standards still apply to businesses making retail or wholesales Out-of-state companies selling other-than-TPP may need to review their sourcing methodology Washington Dept. of Revenue aggressively auditing out-of-state companies to assert nexus Companies still using the old cost method of apportionment can file refund claims o There is a 4 year, plus the current, statute of limitations which runs on 12/31 each year 34
  • SERVICE AND OTHER ACTIVITIES B&O TAX • WA Legislature declined to extend the temporary .3 percent service & other activities B&O tax rate surcharge. Thus, effective July 1, 2013, the service & other activities B&O tax rate is reduced back to 1.5 percent 35
  • WASHINGTON – COMMON PAYMASTER LAW • There has been a lot of audit activity and litigation around payment of common expenses among affiliated groups • The business community has been especially focused on centralized and allocated payroll expenses • SB 5882, effective October 1, 2013, provides advances and reimbursements received by a Common Paymaster may be deducted from the measure of B&O tax in certain situations • “Common Paymaster” is a term for centralized payroll and related human resources services for affiliated entities • No exclusion is allowed under the new law for any employee costs incurred in connection with a contractual obligation of the taxpayer to provide services • WA DOR just released a Special Notice on this law change (9/27/13) 36
  • TEXAS UPDATE 37
  • TEXAS FRANCHISE TAX • Texas imposes a franchise tax on business entities that have physical presence in the state o Having a salesperson enter the state (for even one day) is enough to create nexus • P.L. 86-272 protections do not apply • Tax is imposed on the lesser of: o 70% of gross revenue o Gross revenue less compensation o Gross revenue less cost of goods sold (“COGS”) • Are you maximizing the COGS deduction? 38
  • TEXAS FRANCHISE TAX Opportunity #1: Calculate allowable Texas COGS under Texas definitions • • • • • • • Texas COGS should be calculated separately from Federal COGS Recent changes: Amended COGS rule & internal memorandum to clarify that indirect (supervisor) labor costs related to production and resale activities are included in Texas COGS, as well as employee benefits (health care, travel, meals & entertainment, etc.), pension and other related costs The amended rule references Treasury Rules interpreting IRC Secs. 263A and 460, regardless of whether the taxpayer is required to or actually capitalizes the costs for federal income tax purposes When calculating Texas COGS, a taxpayer need not make the same elections or follow the same safe harbor rules as it does on its federal tax return The amended rule also clarifies that property and other taxes paid in relation to acquiring or producing any material are includable in Texas COGS Service or administrative costs, including mixed service costs which are allocable to the acquisition or production of goods, may be considered COGS, though the includible amount cannot be more than 4 percent of the taxpayer's total indirect or administrative overhead costs Other differences between Federal law and Texas law: o o o Research and development expenditures under IRC Sec. 174 are includable Texas COGS Warranty costs are includable Texas COGS On-site storage costs are includable Texas COGS 39
  • TEXAS FRANCHISE TAX Opportunity # 2: Calculation of Service Costs o A taxpayer can subtract as COGS overhead and administrative costs (“service” costs) that are reasonably allocable to the acquisition or production of goods o The includible amount may not exceed 4% of total indirect and administrative overhead costs o Make sure you are including all eligible service costs in the calculation of the 4% cap  All G&A expenses except for COGS and specifically excluded expenses such as advertising, interest, and selling expenses Other Changes – House Bill 500 • Franchise tax rates are temporarily reduced • Allows additional businesses to qualify as retailers (reduced tax rate) • Expands deductions for certain businesses • Multiple other changes Refund Deadline • Statute runs on November 15 for extended 2008 tax year returns 40
  • NATIONAL UPDATE 41
  • AFFILIATE NEXUS & AMAZON LAWS • Some states have passed laws creating a presumption of nexus if a business has an in-state affiliate • These laws focus on in-state affiliates acting in a representative capacity for the out-of-state company where an agency or affiliate nexus has been created • Merely separating in-state activities to a separate legal entity will likely not be enough anymore to “contain” nexus for income and sales tax purposes • Many states are also adopting “Amazon Laws” and clickthrough nexus regimes to attack out-of-state sellers of goods o Generally, an out-of-state seller creates sales tax nexus with a state when it enters into an agreement with a resident of that state, under which the resident refers buyers via a website link for a commission o Adopted in AR, CA, CT, IL, MN, MO, NC, NY, OH, PA, RI, SC (2016), VT o Many other states are considering 42
  • ECONOMIC NEXUS • States are increasingly moving towards adopting economic nexus standards to capture companies deriving income from sources within the state but may not have any physical activity in the state. Some have defined a specific dollar amount of sales, property or payroll while others have more vague definitions o Examples: Royalty, interest, service income, digital goods, etc. • Sales of services or intangible receipts are not protected under P.L. 86-272. So states seemingly have the right to tax this income absent passage of federal legislation or guidance from the Supreme Court. A state tax nexus case has not been heard since 1992 • States are all over this and has brought a lot of new revenue to states where companies have claimed no nexus • 12 states have adopted and expect more in the future 43
  • ECONOMIC NEXUS • Economic Nexus o Income taxes imposed when a specific dollar amount of sales, property or payroll o Some states have more vague definitions o Applies to income from services, royalties, interest, digital goods o P.L. 86-272 protects sales of tangible personal property Economic Nexus Scorecard – – Factor Presence Nexus • CA (>$500,000 of receipts) • CT (>$500,000 of receipts) • CO (>$500,000 of receipts) • MI (>$350,000 of receipts) • OH (>$500,000 of receipts) • WA (>$250,000 of receipts) Deriving receipts or income from instate sources • IA • KY • MN • NJ • OR • WI 44
  • MARKET-BASED SOURCING FOR APPORTIONMENT • Alternative to Cost of Performance rule • Under the Market-based approach, sales of services are sourced to the state where the service or benefit is received, or where the customer is located • Market-based states: AL, AZ, CA, GA, IL, IA, ME, MD, MA (2014), MI, MN, OH, OK, UT, WA, and WI • Shifts revenue from instate service providers to outof-state service providers selling into the state 45
  • CLOUD SERVICE MODELS Software as a Service (Saas) • • • • Provides customer with access to software, usually over the Internet There is no transfer of tangible personal property The user pays a fee for access to the software Examples: • • • • Online email services Automated human resources software Medical/healthcare databases Accounting & research systems Infrastructure as a Service (IaaS) • • • • • • Customer outsources its information technology functions Provides customer with access to computing power, storage capacity, and other IT infrastructure Customer may maintain control of the software environment There is no transfer of tangible personal property Customer pays a fee for access to a virtual machine Examples of IaaS providers: • • • • Amazon EC2 IBM Rackspace OpSource 46
  • CLOUD SERVICE MODELS Why is this important? Companies selling SaaS may have a sales tax liability. Purchasers consuming SaaS may have use tax liabilities As cloud computing becomes more common, more states are beginning to tax hosted software Most states now have specific sales tax guidance for SaaS, but rules vary widely. Taxability may depend on: • • • • Whether a license or ownership rights are granted to the customer Whether the software is downloaded Whether the software or server is located within the state Whether the vendor is providing a “service” such as data processing services or digital automated services SaaS Scorecard SaaS is subject to sales & use tax in the following states: • • • • • • • • • • Arizona Connecticut District of Columbia Hawaii Idaho Illinois Indiana Massachusetts Michigan New Mexico • • • • • • • • • • New York Ohio Pennsylvania South Carolina South Dakota Texas Utah Vermont Washington West Virginia IaaS is a new concept that states are beginning to address. Expect state guidance in the coming years. 47
  • VOLUNTARY DISCLOSURE AGREEMENTS 48
  • VOLUNTARY DISCLOSURE AGREEMENTS • Almost all states allow a taxpayer with an exposure for current and prior period taxes to come forward and pay tax under a voluntary disclosure agreement • Most will waive penalties, some will waive interest • States will limit the look back period to 3-6 years • Most require the taxpayer not be registered with the state or to have not received notices from the state (some exceptions here) ever or at least within the last year • Most require a third party to represent the taxpayer through the process • The taxpayer remains anonymous until an agreement is reached • May not apply if company has collected and not remitted sales tax • This is a service we do in advance of an equity or sale transaction frequently as due diligence teams always focus on these exposures in their analysis 49
  • PARTING THOUGHTS 50
  • • You may not be filing where you need to. Complete a nexus study and state exposure analysis. State auditors are actively looking for your skeletons • As state laws and cases change apportionment methodologies, you may not be apportioning your company’s sales correctly. Complete an apportionment study, as doing so may reduce your overall tax liability • Your company may not be taking all credits it is entitled to, review where and how you are doing business to determine credits you and your shareholders can take benefit from • If your company has known exposure in states where it is not currently filing, seek a voluntary disclosure agreement • If you receive a state phishing letter, have a state tax professional review it before responding • If your company is paying material tax in Oregon or other states, purchase transferrable credits. If you currently are earning transferring credits, consider monetization • Do a review of your SaaS vendors 51
  • Federal and State R&D Credit Updates Presenters: Star Fischer, CPA – Senior Manager 52
  • TOPICS COVERED • Overview of R&D Credit and Expenditures • Recent Trends in IRS Examinations • Proposed Regulation 1.172-2: Definition of Research Expenditures • Geosyntec Consultants, Inc. v. U.S. (112 AFTR 2013-5488) • U.S. v. Davenport (110 AFTR 2d 2012-5927) • Washington State R&D Credit Opportunities • Oregon R&D Credit Opportunities • California R&D Credit Opportunities 53
  • R&D EXPENSE AND CREDIT OVERVIEW • Governed by IRC 41 and 174 • New or significantly improved product or processes • 4 Part Test o o o o Business Component (Qualified Purpose) Technical Uncertainty Process of Experimentation Technological in Nature • Qualified Expenses o Wages o Supplies o Contract Research (at 65% of cost) • Total federal credit is approximately 6.5% of qualified expenditures • Credits can carry back 1 year and forward 20 54
  • RECENT TRENDS IN IRS EXAMINATIONS • Issue Practice Groups (IPGs) o Replaces IRS Tiered Process • Identification of business components is mandatory o Bayer Corporation & Subs v U.S. (109 AFTR 2d 2012802) • Documentation of qualified activities 55
  • RECENT TRENDS IN IRS EXAM CONTINUED • Differences between IRS Field Exam and Appeals Processes • Renewed Emphasis on Audit Technique Guides o o o o General (June 2005; updated May 2008) Pharmaceutical (April 2004) Aerospace (January 2005) Audit Guidelines on the Application of Process of Experimentation for all Software • Schedule UTP (Uncertain Tax Positions) 56
  • PROPOSED REGULATION 1.174-2 • Significant impact on the definition of qualified R&D expenditures and credit • “The ultimate success, sale, or use of the product is not relevant to the determination of eligibility” • Defines “pilot model” to include a fullyfunctional representation of the product • Taxpayers may rely on these proposed regulations until finalized (Prop. Reg. 1.1742(d)) 57
  • EXAMPLE FROM PROP. REG. 1.174-2 • Example (7). X is a manufacturer of aircraft. X is researching and developing a new, experimental aircraft that can take off and land vertically. To evaluate and resolve uncertainty during the development or improvement of the product and test the appropriate design of the experimental aircraft, X produces a working aircraft at a cost of $5,000,000. The $5,000,000 of costs represents research and development costs in the experimental or laboratory sense. In a later year, X sells the aircraft. Because X produced the aircraft to resolve uncertainty regarding the appropriate design of the product during the development of the experimental aircraft, the aircraft is a pilot model under paragraph (a)(4) of this section. Therefore, the $5,000,000 of costs that X incurred in producing the aircraft qualifies as research or experimental expenditures under section 174. Further, it would not matter if X sold the pilot model or incorporated it in its own business as a demonstration model. See paragraph (a)(1) of this section (ultimate use is not relevant) 58
  • GEOSYNTEC CONSULTANTS, INC. V. U.S. • Are R&D costs incurred in connection with customer contracts eligible for the credit? • Primary issue: Funded Research o Taxpayer must retain substantial rights and have economic risk of failure • Court decided based on type of customer contracts o Fixed Fee/Lump-Sum – Qualified o Cost-Plus– Not Qualified o Guaranteed Maximum (Cost-Plus with a Maximum) – Not Qualified 59
  • GEOSYNTEC CONSULTANTS, INC. V. U.S. • Application of decision o Defines key attributes of contract language that proves the taxpayer has economic risk of failure. o Engineering and other professional service firms can be eligible for the credit o Contract type does not necessarily determine funded research, but is definitely a strong indication o First court case on funded research unrelated to government contracts 60
  • U.S. V. DAVENPORT • Issue: Whether or not activities related to implementation of an ERP system is qualified • Relevant Facts Considered o Software was implemented to automate and integrate aspects of the business o Software was purchased off the shelf and modifications were made • Conclusion o Activities did not meet the process of experimentation test o Activities were more of a quality control/adaptation nature than to develop additional functionality or features 61
  • WASHINGTON R&D CREDIT • Governed by RCW 82.04.4452 • For years ending after 12/31/10, credit is 1.5% of qualified expenditures (over a base amount) • Qualified Research is defined by RCW 82.63.010 o Advanced Computing o Advanced Materials o Biotechnology o Electronic Device Technology o Environmental Technology • Credit cannot exceed $2 million • Survey must be filed with the state by April 30th of the year following the credit being claimed • Although different rules, much of the federal qualified expenditures will be eligible (if in qualified area) 62
  • OREGON R&D CREDIT • Governed by ORS 317.152, 317.153, and 317.154 • Definition of qualified research closely follows IRC 41 with some exceptions o Only research performed in the state is eligible o Oregon has an alternative method that can be optimized by state apportionment o Partnerships are not eligible o Credits carry forward five years if not used o Maximum credit is $1 million for 2012 forward; $2 million for years 2006 – 2011 63
  • CALIFORNIA R&D CREDIT • California Revenue and Taxation Code 23609 • Follows federal definition of qualified research with some exceptions o Research must be conducted in the state of California o Unique base threshold calculations o California Alternative Incremental Credit o Credits carry forward indefinitely if not used • FTB Examinations o R&D credits are highly examined o Significant adjustments are common upon examination o Appeals proceedings are often necessary to retain any benefit 64
  • KEY TAKEAWAYS • The R&D credit remains a top priority audit issue with the IRS • It is key to documentation and support positions in a methodology that is accepted and auditable • The IRS Appeals process is often required to retain the maximum benefit • Court cases are decided and other guidance is issued frequently that significantly impacts positions related to the R&D credit • Most states offer an R&D credit that resembles the federal credit 65