Category: General

Categories
General

Mandatory Capitalization of R&E Expenses — Will The New Rules Impact Your Business?

Businesses that invest in research and development, particularly those in the technology industry, should be aware of a major change to the tax treatment of research and experimental (R&E) expenses. Under the 2017 Tax Cuts and Jobs Act (TCJA), R&E expenditures incurred or paid for tax years beginning after December 31, 2021, will no longer be immediately deductible for tax purposes. Instead, businesses are now required to capitalize and amortize R&E expenditures over a period of five years for research conducted within the U.S. or 15 years for research conducted in a foreign jurisdiction. The new mandatory capitalization rules also apply to software development costs, regardless of whether the software is developed for sale or license to customers or for internal use.

Tax Implications of Mandatory Capitalization Rules

Under the new mandatory capitalization rules, amortization of R&E expenditures begins from the midpoint of the taxable year in which the expenses are paid or incurred, resulting in a negative year 1 tax and cash flow impact when compared to the previous rules that allowed an immediate deduction.

For example, assume a calendar-year taxpayer incurs $50 million of U.S. R&E expenditures in 2022. Prior to the TCJA amendment, the taxpayer would have immediately deducted all $50 million on its 2022 tax return. Under the new rules, however, the taxpayer will be entitled to deduct amortization expense of $5,000,000 in 2022, calculated by dividing $50 million by five years, and then applying the midpoint convention. The example’s $45 million decrease in year 1 deductions emphasizes the magnitude of the new rules for companies that invest heavily in technology and/or software development.

The new rules present additional considerations for businesses that invest in R&E, which are discussed below.

Cost/Benefit of Offshoring R&E Activities

As noted above, R&E expenditures incurred for activities performed overseas are subject to an amortization period of 15 years, as opposed to a five-year amortization period for R&E activities carried out in the U.S. Given the prevalence of outsourcing R&E and software development activities to foreign jurisdictions, taxpayers that currently incur these costs outside the U.S. are likely to experience an even more significant impact from the new rules than their counterparts that conduct R&E activities domestically. Businesses should carefully consider the tax impacts of the longer 15-year recovery period when weighing the cost savings from shifting R&E activities overseas. Further complexities may arise if the entity that is incurring the foreign R&E expenditures is a foreign corporation owned by a U.S. taxpayer, as the new mandatory capitalization rules may also increase the U.S. taxpayer’s Global Intangible Low-taxed Income (GILTI) inclusion.

Identifying and Documenting R&E Expenditures

Unless repealed or delayed by Congress (see below), the new mandatory amortization rules apply for tax years beginning after December 31, 2021. Taxpayers with R&E activities should begin assessing what actions are necessary to identify qualifying expenditures and to ensure compliance with the new rules. Some taxpayers may be able to leverage from existing financial reporting systems or tracking procedures to identify R&E; for instance, companies may already be identifying certain types of research costs for financial reporting under ASC 730 or calculating qualifying research expenditures for purposes of the research tax credit. Companies that are not currently identifying R&E costs for other purposes may have to undertake a more robust analysis, including performing interviews with operations and financial accounting personnel and developing reasonable allocation methodologies to the extent that a particular expense (e.g., rent) relates to both R&E and non-R&E activities.

Importantly, all taxpayers with R&E expenditures, regardless of industry or size, should gather and retain contemporaneous documentation necessary for the identification and calculation of costs amortized on their tax return. This documentation can play a critical role in sustaining a more favorable tax treatment upon examination by the IRS as well as demonstrating compliance with the tax law during a future M&A due diligence process.

Impact on Financial Reporting under ASC 740

Taxpayers also need to consider the impact of the mandatory capitalization rules on their tax provisions. In general, the addback of R&E expenditures in situations where the amounts are deducted currently for financial reporting purposes will create a new deferred tax asset. Although the book/tax disparity in the treatment of R&E expenditures is viewed as a temporary difference (the R&E amounts will eventually be deducted for tax purposes), the ancillary effects of the new rules could have other tax impacts, such as on the calculation of GILTI inclusions and Foreign-Derived Intangible Income (FDII) deductions, which ordinarily give rise to permanent differences that increase or decrease a company’s effective tax rate. The U.S. valuation allowance assessment for deferred tax assets could also be impacted due to an increase in taxable income. Further, changes to both GILTI and FDII amounts should be considered in valuation allowance assessments, as such amounts are factors in forecasts of future profitability.

Insights

The new mandatory capitalization rules for R&E expenditures and resulting increase in taxable income will likely impact the computation of quarterly estimated tax payments and extension payments owed for the 2022 tax year. Even taxpayers with net operating loss carryforwards should be aware of the tax implications of the new rules, as they may find themselves utilizing more net operating losses (NOLs) than expected in 2022 and future years, or ending up in a taxable position if the deferral of the R&E expenditures is material (or if NOLs are limited under Section 382 or the TCJA). In such instances, companies may find it prudent to examine other tax planning opportunities, such as performing an R&D tax credit study or assessing their eligibility for the FDII deduction, which may help lower their overall tax liability.

Will the new rules be delayed?

The version of the Build Back Better Act that was passed by the U.S. House of Representatives in November 2021 would have delayed the effective date of the TCJA’s mandatory capitalization rules for R&E expenditures until tax years beginning after December 31, 2025. While this specific provision of the House bill enjoyed broad bipartisan support, the BBBA bill did not make it out of the Senate, and recent comments by some members of the Senate have indicated that the BBB bill is unlikely to become law in its latest form. Accordingly, as of the date of this publication, the original effective date contained in the TCJA (i.e., taxable years beginning after December 31, 2021) for the mandatory capitalization of R&E expenditures remains in place.

How We Can Help

The changes to the tax treatment of R&E expenditures can be complex. While taxpayers and tax practitioners alike remain hopeful that Congress will agree on a bill that allows for uninterrupted immediate deductibility of these expenditures, at least for now, companies must start considering the implications of the new rules as currently enacted.

Stay informed with R & E  and business information by registering for our newsletter.

Categories
General

WITH BBB OFF THE TABLE, WILL CONGRESS CONSIDER A SMALLER PACKAGE OF TAX PROVISIONS?

With the prospects of a comprehensive U.S. tax legislative package unlikely, one possible path for Congress is the consideration of smaller, more targeted pieces of legislation. One possibility of such targeted tax legislation might be passing tax extenders. Another possible package of tax legislation might include provisions aimed at providing relief from the recent COVID-19 Omicron variant.

Throughout the COVID-19 pandemic and as the country has tackled the many variants, the impact of the virus has been tough on smaller businesses, particularly those that provide services to people, such as restaurants, entertainment venues, hotels and fitness centers/sports clubs.

While no formal legislation has been introduced specifically related to the Omicron variant, if a bill picks up steam, we might see provisions such as employment tax credits, travel incentives or temporary changes to the meal and entertainment cap.

With the Build Back Better bill now a recent memory, members of both parties in the House and Senate may find additional targeted COVID-19 tax relief more appealing. Members of Congress hear from constituents daily regarding their struggles with the impact COVID-19 has had on their lives and on their livelihoods. Pressing ahead with a package of targeted tax relief might be just what many taxpayers need. It may also be just what Congress needs to show it can respond to the needs of Americans in a bipartisan, bicameral basis.

Subscribe today so you’ll never miss information from us.

Categories
General

Higher Energy Prices

Among the many consequences of Russia’s invasion of Ukraine are higher energy prices and fears about oil and gas shortages. But recently, Senate Finance Committee Chairman, Ron Wyden (D-OR) argued that Congress can kill two birds with one stone by passing clean energy tax incentives.

Tax breaks could help reduce the country’s dependence on foreign oil and “prevent the most catastrophic effects of the climate crisis.” Wyden emphasized that the package he proposed in last year’s Clean Energy for America Act, “would lower emissions by the power sector by more than 70%.” Besides containing tax breaks for businesses, it would offer refundable tax credits for consumers who buy electric vehicles.

Categories
General

Can you deduct the costs of a spouse on a business trip?

If you own your own company and travel for business, you may wonder whether you can deduct the costs of having your spouse accompany you on trips. The rules for deducting a spouse’s travel costs are very restrictive. First of all, to qualify, your spouse must be your employee. This means you can’t deduct the travel costs of a spouse, even if his or her presence has a bona fide business purpose, unless the spouse is a bona fide employee of your business. This requirement prevents tax deductibility in most cases.

A spouse-employee

If your spouse is your employee, then you can deduct his or her travel costs if his or her presence on the trip serves a bona fide business purpose. Merely having your spouse perform some incidental business service, such as typing up notes from a meeting, isn’t enough to establish a business purpose. In general, it isn’t sufficient for his or her presence to be “helpful” to your business pursuits — it must be necessary. In most cases, a spouse’s participation in social functions, for example as a host or hostess, isn’t enough to establish a business purpose. That is, if his or her purpose is to establish general goodwill for customers or associates, this is usually insufficient.

Further, if there’s a vacation element to the trip (for example, if your spouse spends time sightseeing), it will be more difficult to establish a business purpose for his or her presence on the trip. On the other hand, a bona fide business purpose exists if your spouse’s presence is necessary to care for a serious medical condition that you have. If your spouse’s travel satisfies these tests, the normal deductions for business travel away from home can be claimed. These include the costs of transportation, meals, lodging, and incidental costs such as dry cleaning, phone calls, etc.

A non-employee spouse

Even if your spouse’s travel doesn’t satisfy the requirements, however, you may still be able to deduct a substantial portion of the trip’s costs. This is because the rules don’t require you to allocate 50% of your travel costs to your spouse. You need only allocate any additional costs you incur for him or her. For example, in many hotels the cost of a single room isn’t that much lower than the cost of a double. If a single would cost you $150 a night and a double would cost you and your spouse $200, the disallowed portion of the cost allocable to your spouse would only be $50.

In other words, you can write off the cost of what you would have paid traveling alone. To prove your deduction, ask the hotel for a room rate schedule showing single rates for the days you’re staying. And if you drive your own car or rent one, the whole cost will be fully deductible even if your spouse is along. Of course, if public transportation is used, and for meals, any separate costs incurred by your spouse wouldn’t be deductible.

Contact us if you have questions about this or other tax-related topics. © 2022

Categories
General Helpful Articles

Unprecedented IRS Backlogs

In response to pressure from Congress, 1,200 IRS employees have been dispatched to sort and process millions of outstanding 2020 amended paper tax returns. IRS Commissioner Chuck Rettig says a separate team will tackle 2021 paper returns as they come in. The backlog has been caused, in part, because the IRS suspended approximately 35 million returns due to errors. But will the IRS’s action plan satisfy legislators? The National Taxpayer Advocate, Erin M. Collins, testified before the Senate Finance Committee that the agency also needs to provide temporary penalty relief to taxpayers, suspend collections and improve communications. In addition, she said the IRS needs sufficient funding to upgrade IT systems.

She told members of the Senate Finance Committee on 2/16/22 during a hearing on IRS customer service challenges, “In releasing my Annual Report to Congress, I said that paper is the IRS’s kryptonite and that the IRS is still buried in it.” She said that taxpayers have been experiencing significant delays in receiving their tax refunds because of unprecedented IRS backlogs in the processing of original and amended tax returns. Paper processing remains the agency’s biggest challenge, and that will continue throughout 2022. As of late December 2021, the IRS still had backlogs of 6 million unprocessed original individual returns (Form 1040 series) and 2.3 million unprocessed amended individual returns (Form 1040-X. E-filed original returns have mostly worked through the backlog. A written copy of her remarks can be found at this website.

Have questions about your 2021 taxes? Schedule an appointment with one of our tax professionals today.

Categories
General Healthcare News

Supreme Court Blocks Vaccine-or-Testing Mandate for Large Employers

On Thursday, January 13, the U.S. Supreme Court blocked efforts by the Biden Administration to put a vaccine-or-testing mandate in place for large employers in a 6-3 vote. The mandate would have required proof of vaccination or weekly COVID testing for businesses that employ at least 100 individuals.

While a vaccine-or-testing mandate will not go into effect for general employers, employees of healthcare facilities that receive money through the Medicare and Medicaid programs must be vaccinated against COVID-19 by the end of February 2022, as decided in a 5-4 ruling.

For more details about the Supreme Court’s ruling on the vaccine-or-testing mandate, visit https://www.reuters.com/world/us/us-supreme-court-blocks-biden-vaccine-or-test-policy-large-businesses-2022-01-13/.

Categories
General

Worker Classification Is Still Important

In 2020 and 2021, many companies have experienced “workforce fluctuations.” If your business has engaged independent contractors to address staffing needs, be careful that these workers are properly classified for federal tax purposes.

Tax obligations

The question of whether a worker is an independent contractor or an employee for federal income and employment tax purposes is a complex one. If a worker is an employee, the company must withhold federal income and payroll taxes, and pay the employer’s share of FICA taxes on the wages, plus FUTA tax. Often, a business must also provide the worker with the fringe benefits that it makes available to other employees. And there may be state tax obligations as well.

These obligations don’t apply if a worker is an independent contractor. In that case, the business simply sends the contractor a Form 1099-NEC for the year showing the amount paid (if the amount is $600 or more).

No uniform definition

The IRS and courts have generally ruled that individuals are employees if the organization they work for has the right to control and direct them in the jobs they’re performing. Otherwise, the individuals are generally independent contractors, though other factors are considered.

Some employers that have misclassified workers as independent contractors may get some relief from employment tax liabilities under Internal Revenue Code Section 530. In general, this protection applies only if an employer filed all federal returns consistent with its treatment of a worker as a contractor and treated all similarly situated workers as contractors.

The employer must also have a “reasonable basis” for not treating the worker as an employee. For example, a “reasonable basis” exists if a significant segment of the employer’s industry traditionally treats similar workers as contractors. (Note: Sec. 530 doesn’t apply to certain types of technical services workers. And some categories of individuals are subject to special rules because of their occupations or identities.)

Asking for a determination

Under certain circumstances, you may want to ask the IRS (on Form SS-8) to rule on whether a worker is an independent contractor or employee. However, be aware that the IRS has a history of classifying workers as employees rather than independent contractors.

Consult a CPA before filing Form SS-8 because filing the form may alert the IRS that your company has worker classification issues — and inadvertently trigger an employment tax audit. It may be better to properly treat a worker as an independent contractor so that the relationship complies with the tax rules.

Latest developments

In January 2021, the Trump Administration published a final rule revising the Fair Labor Standards Act’s employee classification provision. The rule change was considered favorable to employers.

The Biden Administration initially delayed the effective date and then issued a Notice of Proposed Rulemaking (NPRM) to withdraw the rule. After reviewing approximately 1,000 comments submitted in response to the NPRM, it withdrew the rule change before the deferred effective date. Contact your tax advisor for any help you may need with employee classification.

© 2021

Categories
General

House Ways And Means Committee Advances Tax Legislation As Part of Reconciliation Bill

After almost 40 hours of debate over four days, the House Ways and Means Committee on September 15 approved a tax package that would increase rates on high-net-worth individuals and corporations and affect cross-border activity and pass-through entities, advancing the tax elements of the Biden administration’s “Build Back Better” agenda.

The package advanced on a largely party-line 24-19 vote – no Republicans voted for it, and only one Democrat, Rep. Stephanie Murphy, D-Fla., voted against it.

As the next step in the legislative process, the legislation now goes to the House Budget Committee, where it will be combined with bills from other House committees and eventually brought before the full House for a vote as the reconciliation legislation.

Individuals

The draft legislation would raise the top individual marginal tax rate from the current 37% to 39.6% for taxable income over $450,000 for married individuals filing jointly and surviving spouses, $425,000 for head of households, $400,000 for single individuals, $225,000 for married individuals filing separately, and $12,500 for estates and trusts. The proposal would be effective for taxable years beginning after December 31, 2021.

The capital gains tax rate would rise to 25% from 20% for transactions by high-income individuals made after Sept. 13, 2021.

The bill would also create a 3% surcharge on modified gross adjusted income above $5 million, and set a limit on contributions to large individual retirement accounts.

The bill would extend the holding period to obtain long-term capital gains treatment for gain allocated to carried interest partners from three to five years. The three-year holding period would remain in effect with respect to any income attributable to real property trades or businesses and for taxpayers (other than an estate or trust) with adjusted gross income of less than $400,000.

Business Provisions

The legislation would introduce a graduated income tax rate structure for most corporations, with a top corporate tax rate of 26.5%. Corporations with taxable income that does not exceed $400,000 would be subject to a new 18% tax rate (lower than the current 21% rate), while those with income that exceeds $400,000 but does not exceed $5 million would be subject to a 21% tax rate, and those with income in excess of $5 million would be subject to the top 26.5% rate.

On the international front, the bill would reduce the Section 250 deduction for global intangible low-taxed Income (GILTI) to 37.5%, resulting in an effective tax rate of 16.5% based on a corporate tax rate of 26.5%. The GILTI would be calculated on a country-by-country basis. Other international tax provisions include:

  • The deduction for qualified business asset investment (QBAI) would be reduced to 5%;
  • The foreign tax credit haircut would be reduced to 5%;
  • The tax on foreign-derived intangible income would rise to an effective rate of 20.7% based on a corporate tax rate of 26.5%;
  • Excess foreign tax credit carryforwards would be allowed for five years but carrybacks would be disallowed; and
  • A new limitation on interest expense deductions for some multinational corporations would be introduced.


What’s Not in the Bill

The Ways and Means tax bill does not include any changes to the cap on individual itemized deductions for state and local taxes, which was introduced in 2017’s tax reform. Ways and Means Chairman Richard Neal (D-MA) has said he is committed to include “meaningful SALT relief” in the final legislation.

A provision to end the tax-free step-up in basis above a $1 million threshold that was proposed by the Biden administration is also not included in the Ways and Means bill.

 

Written by Todd Simmens. Copyright © 2021 BDO USA, LLP. All rights reserved. www.bdo.com

 

Categories
General

Potential Benefits of Section 1202 Continue to Grow

Section 1202 of the Internal Revenue Code is growing in popularity among investors and may become even more valuable in 2022.

Section 1202 allows founders and investors of corporations to exclude up to 100% of their capital gains derived from the sale of qualified small business stock (QSBS) held for more than five years (subject to limitations). Because the gain exclusion percentage for a shareholder depends on the QSBS issuance date, as time goes on more investors are becoming eligible for the full, 100% exclusion—and thus its rise in popularity.

Further, the 2021 Green Book proposes far-reaching changes to the taxation of long-term capital gains, which are taxed at graduated rates under the individual income tax. Today, the highest rate is generally 20% (23.8% including the net investment income tax, if applicable, based on the taxpayer’s modified adjusted gross income (AGI)).

Under the Green Book proposal, long-term capital gains of taxpayers with AGI of more than $1 million would be taxed at ordinary income tax rates to the extent that the taxpayer’s income exceeds $1 million ($500,000 for married filing separately), indexed for inflation after 2022. Currently, the highest rate for individuals is 37% (40.8% including the net investment income tax), though the Green Book also includes a proposal to raise the individual rate to up to 39.6% (43.4% including the net investment income tax).

While reinvestments into Qualified Opportunity Zones, like-kind exchanges for real property (possibly limited going forward), and reinvestment of proceeds into qualified replacement property from sales of corporate stock to an Employee Stock Ownership Plan of 30% or more of the corporation’s outstanding stock provide some deferral opportunities, Section 1202 is the only provision that provides an exclusion opportunity for QSBS. The higher that the capital gains tax rate goes up, the greater the potential tax benefit of utilizing an available Section 1202 exclusion.

Categories
Construction General Helpful Articles Jackson, TN Memphis, TN

Protect Your Construction Company from the Effects of High Supply Prices

Building supply manufacturers are doing their best to catch up with the high demand for their materials. Material prices overall are continuing to climb, making it difficult for contractors of all types and sizes to provide their services in the same manner they did before the pandemic as well as grow their businesses.

What can contractors do?

Communication is key for contractors and business owners right now. It is important for clients to know developments in supply chains and pricing. Much of the information that should be communicated can be included in contracts. Even though they cannot impact the supply chain and prices of materials, contractors can protect themselves from losing money and work through several means.

  • Expiration Dates

With prices and supply availability changing every day, contractors cannot guarantee a price for long. Since there is a chance that original quotes can change at a moment’s notice, contractors can explain that their quote is only viable until a certain date. 

  • Delay Clauses

Since there are typically damages contractors must claim when a job is not completed by the projected date, it is important for contractors to include delay clauses in their contracts. With the pandemic and the unknowns of the building materials supply chains, contractors cannot be held accountable for the delay in construction due to lack of materials.

Need more insight?

Our experts are consistently keeping tabs on industry changes. Contact one of our representatives today for consulting that will keep your business running smoothly and productively in the midst of unknowns.