R&D Tax Credit Update. Randy Emmons, CPA, Senior Manager R&D Tax Services, BDO USA LLP Mike Varner, CPA, Partner Kruggel Lawton CPAs

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1 R&D Tax Credit Update Randy Emmons, CPA, Senior Manager R&D Tax Services, BDO USA LLP Mike Varner, CPA, Partner Kruggel Lawton CPAs CFO Summit November 8, 2017

2 R&D Tax Credit Topics Recent Developments Eligibility: Who and What Qualifies for the R&D Credit Benefit: What are the Benefits of the R&D Credit Q/A 2

3 Recent Developments Path Act Funded Research Court Cases Internal Use Software Final Regs Alternative Simplified Credit Collection 280C Election IRS Directive for LB&I Claims 3

4 Recent Developments Path Act - Enhancements Made the R&D tax credit permanent (effective immediately) For taxable years beginning after December 31, 2015: Allows Eligible Small Businesses to utilize the credit against AMT, and Allows Qualified Small Businesses to utilize the credit against Employer Payroll tax AMT Offset - Eligible Small Business means, with respect to any taxable year - (i) a corporation the stock of which is not publicly traded, a partnership, or a sole proprietorship, (ii) if the average annual gross receipts of such corporation, partnership, or sole proprietorship for the 3-taxable-year period preceding such taxable year does not exceed $50,000,000. 4

5 Recent Developments Path Act - Qualified Small Businesses Qualified Small Business are corporations, partnerships, or persons (i) not exempt from income tax under IRC section 501; (ii) with gross receipts in the taxable year of less than $5 million; and (iii) with no gross receipts prior to the five taxable years ending in the taxable year Ability to claim credits (up to $250,000) as a payroll tax credit against employer s portion of payroll taxes Can only be made for 5 years Certified Professional Employer Organization ( CPEO ) / Section 3504 Agent All members of the same controlled group treated as a single taxpayer Each member may separately elect the payroll tax credit but not in excess of its allocated amount 5

6 Recent Developments Final Regulations for Internal Use Software ( IUS ) Effective Date released October 4, 2016 effective for tax years beginning on or after this date. For taxable years that both ends on or after 1/20/2015 and begins before 10/4/2016, the IRS will not challenge return positions consistent with proposed Regs from 1/20/2015. Client facing software now considered non-internal use (e.g. extranets, ecommerce with outside parties) 6 Internal-use software qualifies if: Meets 4-part test R&D tax credit criteria Is not commercially available Is a significant economic risk for the company Uncertainty is present at the onset of the project regarding the capability or method of the software development activity

7 Recent Developments Alternative Simplified Credit (ASC) Election Treasury and the IRS issued final regulations that allow certain taxpayers to elect the ASC on amended returns. (T.D. 9712) Previously, taxpayers could elect the ASC for a taxable year only on that year s timely-filed original return. WHY IS THIS A BIG DEAL? PRACTICAL ISSUES W/ HAVING NOT MADE ELECTION. 1. MUST MAKE ASC ELECTION ON AN AMENDED RETURN 2. CAN ONLY MAKE FOR TAX YEARS THAT ARE STILL OPEN FOR ASSESSMENT UNDER 6501(A) 3. WHY IS THIS RELEVANT? WHAT DOES THIS PREVENT? 4. STILL MUST MAKE 280C ELECTION ANNUALLY ON ORIGINAL RETURN. 5. WHAT SHOULD YOU DO? If you know, make election. If you don t, make 280C but assess methods and file amended return to elect ASC (if appropriate) w/in period open for assessments. 7

8 Recent Developments IRC Section 280C Election Purpose: File a protective Form 6765 to make a 280C election on an originally filed return to minimize the risk of creating an AMT condition on future amended returns and/or creating the need to amend state returns. This election can be made without claiming a credit. If the taxpayer does not elect the reduced credit under 280C, the taxpayer must reduce the otherwise allowable deduction for qualified research expenses ("QREs") by the amount of the unreduced credit. This reduction is known as "the 280C add-back." If the credit exceeds the amount allowed as a deduction for the tax year, the taxpayer must reduce the amount chargeable to capital account for the year for such expenses by the amount of the excess. Procedure: In Form 6765, under Section A on line 17 (Are you electing the reduced credit under section 280C?) check the box YES and input the word NONE in the amount box. *** Again, do not input a dollar amount just enter NONE *** 8 Attach a statement: Referenced on Line 17 via STATEMENT XXX : The taxpayer s intent is to elect the Section 280C reduced credit on an originally filed Form 6765 and is not electing an research credit method under either Section A or B.

9 Recent Developments IRS Directive ASC 730 Impacts Clients subject to Large Business & International division of the IRS i.e. Assets equal to or greater than $10,000,000. Provides an efficient manner of determining QREs Application for certification of credits using modified ASC 730 expenses. Examiners will not challenge adjusted ASC 730 Financial Statement R&D costs for the Credit Year. Additional QREs above ASC 730 are subject to risk assessment, if warranted. 9

10 Eligibility Who and What Qualifies for the R&D Credit? 10

11 Eligibility Activities Qualified Research Permitted Purpose Test attempt to develop or improve the functionality, performance, reliability, or quality of a business component A business component is a product, process, software, technique, invention, or formula which is to be either (1) held for sale, lease, or license, or (2) used by the company in one of its trades or businesses Process of Experimentation Test 80% or more of the activities must comprise a process of experimentation, i.e., a process designed to evaluate one or more alternatives to achieve a result where both: Technological in Nature Test - that process fundamentally relies on the principles of engineering or the physical, biological, or computer sciences; and Uncertainty Test - the capability or the method of achieving that result, or the appropriate design of that result, is uncertain at the activities outset 11

12 Eligibility Activities Statutorily - Excluded Activities Related to style; taste, except biological taste; cosmetic or seasonal factors Relies on social science, arts, or humanities. Must be technological in nature Funded by an unrelated person or governmental entity Conducted outside the U.S. Management surveys, efficiency studies, market research, etc. Routine data collection and ordinary quality control Intended to develop software primarily for internal-use. Exceptions exist. The following activities, unless they meet the five tests outlined above: After commercial production Adapting an existing component to a particular customer s requirements Duplicating an existing business component 12

13 Eligibility Costs Qualified Research Expenses ( QREs ) Wages: taxable W-2, box 1 wages of employees who perform or directly supervise or directly support Qualified Research ( Qualified Services ) Stock options subject to withholding qualify Supplies: costs for tangible, personal property, not of a character subject to the allowance for depreciation, used in qualified research Contractor Research Expenses: 65%, 75%, or 100% of payments to contractors for Qualified Services, depending on the nature and activity of the contractor, and provided the payments were not contingent on the activity s success and the taxpayer retained substantial rights to the research s results Computer rents/leases. Computer can t be owned by company or on company s premises 13

14 Eligibility Industries IRS information for corporations for TY2012 Industry Manufacturing Credit Amount # of Returns Average Credit % of Credit Amount 6,594,800,000 6,219 1,060,428 61% Information 1,747,717,000 1,583 1,104,054 16% Professional, scientific & technical services 1,126,862,000 5, ,421 10% Wholesale & retail trade 769,282,000 1, ,284 7% Finance and insurance 226,544, ,211 2% Management of companies 85,180, ,365 1% Mining 79,614, ,889 1% Utilities 51,640, ,746 0% Administrative/support & waste mgmt 44,822, ,851 0% Other services (e.g., health, entertainment, hospitality) 35,263, ,845 0% Real estate, rental, and leasing 28,087, ,524 0% Construction 24,074, ,308 0% Transportation & warehousing 20,444, ,483 0% Agriculture, forestry, fishing & hunting 8,239, ,644 0% Total 10,842,568,000 15, , % 14

15 Benefit What is the benefit of the R&D credit?

16 Benefit Federal Research Tax Credit Up to 6.5% or 9.1% of qualified spending Reduce regular income tax liability Reduce effective tax rate Increase earnings Increase cash flow 16

17 Benefit State Research Tax Credits Most states offer R&D credits Averages 5%-10% of qualified spending Most follow federal rules but can differ in some key areas Refundable credits, e.g.: - Arizona - Connecticut - Hawaii - Iowa - Louisiana - Nebraska - Virginia - West Virginia Transferable or saleable credits, e.g.: - New Jersey - Pennsylvania Indiana Audit update Illinois Recently renewed 17

18 18 Q&A

19 Tax Cuts and Jobs Act House GOP tax reform bill released 11/2/2017 The Tax Cuts and Jobs Act will simplify the code so you can file your taxes on a form the size of a postcard. House Speaker Paul Ryan CFO Summit November 8, 2017

20 20 Quick Varner Family Update

21 Individual Income Tax 21 Increases the Standard Deduction to: $12,000 Single $18,000 Head of Household $24,000 Married filing Joint Eliminates additional standard deductions and personal exemptions Having more kids doesn t increase your deductions. In fact, more kids could mean more tax

22 Individual Income Tax Child Tax Credit enhanced to $1,600. Also a $300 Family Flexibility credit for each parent and non-child dependent. Income phase-out for these credits would increase from $110,000 to $230,000 (MFJ) Eliminates AMT (partial AMT credit carryovers will be allowed). Hooray, but Eliminates state and local income tax deduction Property Tax deduction capped at $10,000 This is an offset or payback for the AMT repeal and impacts those who weren t in AMT in the first place! 22

23 Individual Income Tax 23 Mortgage interest deduction only allowed for existing mortgages and new purchases with loans of $500,000 or less Mortgage interest is only deductible on a principal residence Home equity loan interest incurred after 11/2/17 is not deductible Changes to exclusion of gain from sale of principal residence own and live 5 out of 8 years

24 Individual Income Tax No more AGI phaseout of the remaining allowed itemized deductions Charitable AGI limitation up from 50% to 60% No more 80% charitable deduction of the amount paid for the right to purchase college athletic event tickets No more deduction for tax preparation fees No more medical expense deduction 24

25 Individual Income Tax Eliminates the moving deduction, student loan interest deduction, alimony deduction, adoption credit and other miscellaneous credits and deductions College tax credits will be streamlined into one credit Retirement contributions unchanged for now Consolidates 7 tax brackets into 4 Single Married Head of Household 12.0% > $0 12.0% > $0 12.0% > $0 25.0% > $45, % > $90, % > $67, % > $200, % > $260, % > $230, % > $500, % > $1,000, % > $500,000 25

26 Individuals owning Businesses 26 Small Business owners and pass-through entity owners Creates a new 25 percent tax rate on pass-through business income, subject to anti-abuse rules Only capital percentage is taxed at the lower rate Safe harbor of 30% will be subject to the lower rate. 70% at normal rates Or multiply the capital investments of the business by the federal short term rate + 7%. Elect this formula and you are locked in for 5 years Passive businesses get the 25% rate in full 100%??? Service businesses CPAs, attorneys, consultants, engineers - no benefit. Doctors???

27 Business Tax 27 Lowers corporate income tax rate from 34 percent to a flat 20 percent rate Full expensing of short-lived capital investment, such as machinery and equipment, for 5 years (retroactive to 9/27/17) Increases Section 179 expensing to $5 million and increases phase-out threshold to $20 million Not sure why we need Section 179 and full expensing? Modification of NOL carryovers 90% rule and interest factor on carryover Generally no carryback

28 Business Tax Eliminates like-kind exchanges for personal property (real property like-kind exchanges still allowed) Tightens deductions for entertainment expenses Eliminates Corporate AMT Repeals Domestic Production Activities Deduction Repeals employer-provided child care credit, work opportunity tax credit, historical building rehabilitation credit, and other miscellaneous credits 28

29 Business Tax Interest expense deduction limitation Limited by 30% of adjusted taxable income Taxable income before Interest NOLs Depreciation/Amortization 5-year carryover of disallowed portion 29

30 Partnership Tax The technical termination rule would be repealed The partnership would be treated as continuing even if more than 50 percent of the total capital and profit interests of the partnership are sold or exchanged New elections would not be required 30

31 Estate and Gift Tax Increases the estate tax exemption to $10 million Estate tax is phased out over the next 6 years until it is completely repealed Heirs still receive a stepped-up basis! Say WHAT? Gift tax is lowered to a top rate of 35% and retains a basic exclusion of $10 million and an annual exclusion of $14,000 to be indexed for inflation 31

32 32 Questions?

33 Biography Randy C. Emmons Senior Manager RELEVANT EXPERIENCE Randy is a Senior Manager with BDO s R&D Tax Services Practice for the Central U.S. Region and is located in the Grand Rapids, Michigan office. remmons@bdo.com Direct: Mobile: Ottawa Avenue NW Suite 300 Grand Rapids, MI Tel: Fax: Industry Focus: Manufacturing Automotive Defense Engineering & Architectural Consumer Products Food Products Software Aerospace For ten years Randy has worked full time in the area of U.S. federal and state R&D tax services. Randy has designed and implemented procedures for small privately held to billion dollar companies to identify and document their R&D costs and activities, as well as assisting in effectively supporting 90% of credits claimed on IRS and/or state taxing authority examinations. Randy s experience include servicing a wide range of companies in the following industries: Aerospace; Automotive; Consumer Products; Defense; Energy; Food & Beverage; Online Retail; Semiconductor Manufacturing; and Software. PROFESSIONAL AFFILIATIONS Michigan Association of Certified Public Accountants EDUCATION B.B.A Grand Valley State University Accounting & Finance BDO USA, LLP, a New York limited liability partnership, is the U.S. member of BDO International Limited, a UK company limited by guarantee, and forms part of the international BDO network of independent member firms.

34 Michael E. Varner, CPA, CGMA Partner Phone: , ext Experienced in tax compliance and consulting services for closely held businesses and their owners in the manufacturing, hospitality, hotel/restaurant, and tourism industries. EXPERIENCE Creating his niche in multi-state manufacturing companies, Mike has been able to tailor his accounting expertise to the unique situations those businesses encounter. Some of the more specific issues involve cost segregation, succession planning and tax strategies. Specifically, his more than 20 years experience includes: Review of federal, state and local tax returns (income, property and payroll) for corporations, limited liability companies, partnerships and individuals Review and analysis of various business transactions to assess and minimize tax ramifications, including acquisition, divestitures and reorganizations Nexus study preparation and review for multijurisdiction tax compliance Gift, estate and wealth management planning In addition to his professional roles, Mike is actively involved in the firm's recruitment of new hires. He participates in college career fairs to identify potential intern candidates and also assists in recruiting experienced hires. PROFESSIONAL MEMBERSHIPS American Institute of Certified Public Accountants Indiana CPA Society COMMUNITY INVOLVEMENT Child and Parent Services (CAPS), past board chair Goshen College, former adjunct professor Goshen Noon Kiwanis, board member Junior Achievement, volunteer INTERESTS Mike enjoys his service involvement within the Goshen community, always working to keep a balance with his wife and four active children. When he does steal a moment for himself, he plans a good bike ride, or round of golf, yet other times is happy in his own driveway, tinkering on his prized Jeep Wrangler. EDUCATION Bridgewater College, Bridgewater, VA B.S. in Administration SOUTH BEND, IN 210 S. Michigan St., Ste 200 P: ELKHART, IN 317 W. Franklin St. P: ST. JOSEPH, MI 805 Van Brunt Ave. P: Rev