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Now’s the Time to Kick Off Year-End Tax Planning

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Sep 9th 2015
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With fall upon us, it's easy to get caught up in the excitement of the new football season and forget that now is the perfect time to begin year-end tax planning for your business. Below you will find four strategies to help keep your planning on track.

Review Your Playbook: Cost Segregation Studies
If your business has recently purchased property or is in the process of building construction, cost segregation can help increase the tax depreciation benefit by reapportioning that investment into the appropriate property classes. For tax purposes, nonresidential buildings – classified as “real property” by the IRS – are depreciated using the straight-line method over 39 years, meaning you deduct the same depreciation amount for each of the 39 years. Personal property, on the other hand, is depreciable over a period of five, seven, and 15 years under the Modified Accelerated Cost Recovery System (MACRS) double declining method.

How do you know whether certain property qualifies as “real” or “personal?” During the course of the study, “special system” and permanency tests are conducted to determine how the component should be defined. Under the special system test, a component or system that is specific to the taxpayer's business could be defined as personal property. However, if the component is determined to be an integral part of the operation of the building and is generally adaptable to most businesses, it may not be able to be segregated.

Permanency is determined in part by whether the asset was designed with the intent to be moved, as well as by the cost and damage that would be incurred from moving it. If the component is deemed permanent, it can't be segregated from the rest of the building as personal property. Underlying this criteria are the rules in regulation §1.48-1(c) that define personal property as “any tangible property except land and improvements … such as buildings or other inherently permanent structures (including items which are structural components of such buildings or structures).”

The ultimate goal of a cost segregation study is to unlock tax benefits by identifying building components that can be reclassified as personal property, thus accelerating depreciation deductions, reducing tax liability, and improving cash flow. Qualified personal property could also be eligible for an additional 50 percent bonus depreciation if Congress passes an extension retroactive to 2015, as lawmakers did in December 2014.

Leverage Your Trick Plays: Research and Development
As with bonus depreciation, the research and development (R&D) tax credit expired on Jan. 1, 2015. Even though the availability of 2015 R&D credits remains uncertain, there may be an opportunity to reap tax benefits from prior-year R&D investments.

The R&D credit can be computed in one of two ways. Under the “old” method, the credit is equal to 20 percent of research expenditures in excess of a “base period” amount. The old method base period calculation could require looking back to tax years 1981 to 1984 for research expenditures and gross receipts.

The newer method, known as the alternative simplified credit (ASC), is, as its name implies, far less cumbersome to calculate and presents a substantial opportunity for taxpayers looking to complete a study for previous tax years. Under the ASC, the credit is equal to 12 percent of current-year research expenditures in excess of 50 percent of the average of the previous three years' research expenditures.

And while Congress has yet to extend the federal R&D tax credit for 2015, several states, including, but not limited to, Indiana, Ohio, and Texas, offer local businesses their own version. Businesses should take advantage of R&D tax credits at the state and federal levels.

Check Your Away Schedule: Section 199 Domestic Production Activities
If your business engages in manufacturing activities within the United States, you may be eligible for an additional permanent deduction under code Section 199.

Eligible manufacturing and production activities include:

  • Manufacturing, production, growth, or extraction of tangible personal property in the United States.
  • Construction of real property in the United States.
  • Performance of engineering or architectural services in the United States, in connection with real property construction projects in the United States.

The deduction is equal to the lesser of 9 percent of taxable income, 9 percent of qualified production activities income (QPAI), or 50 percent of W-2 wages. The deduction can be claimed as long as the product in question was produced “in whole or in significant part” within the United States. The “in whole or in significant part” test is determined on an item-by-item basis, and as long as 20 percent of the total cost of the item consists of labor and overhead attributable to the United States, a safe harbor rule allows for the entire item to be included in QPAI. Alternatively, if the safe harbor cannot be reached, the gross receipts attributable to the component parts manufactured in the United States could be included in QPAI.

If the safe harbor is not used to compute QPAI, documenting the facts and circumstances is critical in the event of an IRS audit. Be wary that Section 199 has historically been an area of increased IRS scrutiny and requires complete and accurate claims and reporting.

Consider New Uniforms: Tax Rate Reductions Under the IC-DISC
If your company is organized as a flow-through entity and you can claim profitable export sales, you may be able to increase after-tax cash flow up to 20 percent. By electing to be treated as an interest-charge domestic international sales corporation (IC-DISC), you can convert what would be ordinary income – taxable at a maximum rate of 43.4 percent – to capital gain income taxable at a maximum rate of 23.8 percent. If your exports have already qualified under Section 199, rate-reduction benefits under the IC-DISC may also be available.

The IC-DISC is a separate tax entity organized as a C corporation. That C corporation files Form 4876-A electing to be treated as an IC-DISC, which links the IC-DISC/C corporation to the exporting process of the operating entity. As a service provider to the operating entity, the IC-DISC earns a “commission” payable from the operating entity. The commission is an ordinary deduction to the operating entity and is tax-free income to the IC-DISC. When the IC-DISC distributes the income it earns, the distribution is taxable to the IC-DISC shareholders at qualified dividend or capital gain rates, rather than ordinary income rates.

A good-faith estimate of the commission must be paid to the IC-DISC within 60 days of year-end. The final commission is calculated when the IC-DISC return is due, eight-and-a-half months after year-end. The final payment as reported on the IC-DISC tax return is due 11-and-a-half months after year-end.

In order for the IC-DISC election to be valid, Form 4876-A must be filed within 90 days of the first day of the corporation's first tax year. Or, if it is not the corporation's first tax year, the election is due within the 90-day period preceding the first day of the next tax year. Further, the benefits of the IC-DISC can only be claimed for sales occurring after the DISC is in place.

Just like football players take advantage of training camp prior to the official season starting to perfect their game-winning strategies, businesses need to do the same to ensure their tax game is on point when it's time for tax season kickoff. You already have the tax-planning playbook; now you just have to carry the ball. Take advantage of the final months before the end of 2015 to plan ahead and you'll score major tax benefits for the upcoming year.

About the authors:
Doug Bekker is a tax partner and Larry Figueroa is a core tax services senior associate at BDO USA LLP.

Related article:

Fundamentals of the R&D Tax Credit

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