Reduce your income tax liabilities: two tax credit opportunities can reduce current and future income tax obligations.
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Two strategic tax credit opportunities, the Credit for Increasing Research Activities and the Work Opportunity Tax Credit, can help reduce current and future income tax obligations. Following are details about each of these opportunities.
Cash in on R&D
The Credit for Increasing Research Activities, commonly referred to as the Research Tax Credit or Research and Experimentation (R&E) Tax Credit, is a wage-based credit that rewards companies for investing in the development or improvement of theft products or manufacturing processes. More than two-thirds of companies claiming the Research Tax Credit are in the manufacturing sector (Fig. 1).
The credit is temporary; however, Congress has extended or re-enacted the program on a regular basis since its introduction in the 1980s. On Oct. 3, 2008, Congress signed into law H.R. 1424, the Emergency Economic Stabilization Act of 2008, which extended the Research Tax Credit for qualified expenditures paid or incurred through Dec. 31, 2009. Over time, several bills have been proposed to make the credit permanent, including six bills currently being considered by Congress. One bill, H.R. 1545, adds a bonus tax credit of up to 20% for companies that earn more than 50% of their gross receipts from domestic manufacturing activities.
In addition to extending the credit for expenditures paid or incurred through Dec. 31, H.R. 1424 includes two major changes to the research credit. First, it repeals the Alternative Incremental Research Credit for tax years beginning i after Dec. 31, 2008. Second, it increases the credit rate of the elective Alternative Simplified Credit (ASC) from 12% to 14% for tax years ending after Dec. 31, 2008.
The ASC may be advantageous to some metalcasters who were unable to take advantage of the regular credit, and the recent increase in the ASC rate makes electing this methodology more attractive for taxpayers who:
* are significantly increasing their qualified research expenditures;
* cannot substantiate their qualified expenditures and gross receipts during the base period;
* have gross receipts that have grown exponentially in proportion to their qualified research expenditures;
* historically have acquired or disposed of many companies or divisions.
Further, the U.S. Tax Court recently ruled favorably on a number of issues that taxpayers have found contentious with the Internal Revenue Service (IRS). The most notable ruling allows the taxpayer to estimate the amount of time spent on qualified research activities, when the estimate is supported with employee testimony and corroborating evidence.
While metalcasters will have an easier time claiming the credit if they have documentation that establishes a connection between qualified projects, activities and the personnel who are engaged in this qualified research, the Tax Court has recognized that it is not possible for taxpayers to maintain these records if they were not aware of the need to do so and supports the use of estimates. In the absence of dated records, it is recommended that a system be put into place to assist with the tracking of both project and time related records.
Metalcasters who are considering taking advantage of the R&E Tax Credit should maintain records to support the claim of research and experimentation activities. These records can include:
* copies of emails and other correspondence;
* drawings and CAD models;
* vendor proposals and quotations;
* meeting agendas and minutes;
* production records and lab reports;
* logs or other records showing the amount of time spent on qualified activities.
Generally, the company's CPA or accounting firm may be familiar with the R&E Tax Credit, but because this is such a specialized area of the tax code, the assistance of a specialized provider familiar with the industry can be beneficial to maximize the benefit to the taxpayer.
The Work Opportunity Tax Credit provides an incentive for companies to hire targeted groups of workers, thereby assisting them to move off of public assistance programs.
On May 25, 2007, Congress signed into law the Small Business and Work Opportunity Act of 2007, which extended the tax credit through Aug. 31, 2011.
Unlike the Research Tax Credit, this general business credit must be applied for in the current tax period. Taxpayers must establish that the employee is a member of one of the qualifying targeted groups by submitting a pre-screening notice to a designated local agency within 28 days of the employee's start day.
Employees must belong to one of 11 groups in order for an employer to qualify for the tax credit. They are:
* any individual who has been determined eligible for financial assistance under title IV-A of the Social Security Act;
* qualified veterans;
* qualified ex-felons;
* designated community residents;
* vocational rehabilitation referrals;
* qualified summer youth employees;
* qualified food stamp recipients;
* qualified Supplemental Security Income recipients;
* long-term family assistance recipients;
* unemployed veterans (2009 and 2010 only);
* disconnected youth (2009 and 2010 only).
The U.S. Department of Labor Employment and Training Administration website (www.doleta.gov) has more detailed information about these categories. The Work Opportunity Tax Credit program can provide the following potential benefit to the hiring company:
* $2,400 for each new adult hire;
* $1,200 for each summer youth hire;
* $4,800 for each new disabled veteran hire;
* $9,000 for each new employee hired over a two-year period that received Temporary Assistance for Needy Families payments.
To take advantage of the tax credit, employers must receive approval from its state workforce agency (SWA), certifying that the new hire is a member of one of the target categories. The forms required for the certification am available on the IRS and Department of Labor Employment and Training Administration websites (www.irs.gov and www.doleta.gov). Once the approval is received from the SWA, the credit is calculated based on a percentage of qualified first-year wages. Both the percentage and the maximum applicable wages vary according to the target group to which the employee belongs. The credit then is claimed on the company's federal tax return.
Improve Cash Flow With a Cost Segregation Study
Metalcasters don't have to rely on tax credits to reduce their income tax liability. A cost segregation study can minimize a company's overall tax burden.
Cost segregation studies analyze the drawings, documents and costs relating to a building and its improvements. In most facility projects, the costs of real property, land improvements and personal property are combined for depreciation purposes. Real property, land improvements and personal property are treated differently for depreciation purposes and the resulting income tax consequences. An engineering-based cost segregation study allows building owners to classify their assets appropriately and depreciate their assets in the shortest amount of time permissible under existing tax laws.
A cost segregation study identifies which assets qualify for depreciation over shorter recovery periods and provides the taxpayer with:
* better detail and classification of assets;
* improved cash flow by accelerated tax benefits;
* maximized depreciation of assets for tax purposes;
* identification of costs that may be immediately expensed;
* better detail of fixed asset records.
For metalcasting companies that own their facilities, a cost segregation study can significantly defer taxable income by increasing the organization's depreciation expense. Significant portions of the facility can be classified into asset classes with shorter depreciable lives, thus increasing the company's depreciation expense in the earlier years and deferring taxable income.
The standard depreciable life for commercial buildings is 39 years. Many times, taxpayers can significantly reduce the tax life of these assets to five, seven and 15 year lives. According to the Journal of Accountancy, published by the American Institute of Certified Public Accountants, each $100,000 in assets reclassified from a 39-year recovery period to a five-year recovery period results in approximately $16,000 in net-present-value savings, assuming an 8% discount rate and a 40% marginal tax rate. Typically, between 30% and 60% of a heavy manufacturing property (such as a metalcasting facility) can be reallocated from real property into the shorter-life personal property asset classes.
Moreover, companies may perform cost segregation studies for both new and existing locations. Under current Internal Revenue Service rules, when using a cost segregation analysis, companies may deduct in the year of the change 100% of the depreciation that the company was legally entitled to but did not claim due to the original classifications. Taxpayers have the ability to retroactively "catch up" the depreciation deductions that would have been taken in the event the assets had been segregated at the time the building was placed in service. Metalcasters therefore can save significant tax dollars through increased depreciation expenses for the year the cost segregation study is performed.
The documentation required to undertake a cost segregation study consists of the facility drawings, which will include the architectural plans along with the designs for the electrical, mechanical and other systems associated with the building. Cost segregation studies are usually conducted by engineering specialists who are familiar with the engineering-based analysis required for the study which can then be delivered to the company's accounting service provider.
For More Information
"Research Pays Your Taxes," A. Herman, M. Devereux II and Richard Wile, MODERN CASTING, January 2008, p. 32.
Adam J. Herman, CPA/ABV/CFF, CVA, ASA, Michael L Devereux II, and Richard L. Wile, CMBA, are members of MPP&W, P.C. 's R&E Tax Credit Group, a division of a regional, St. Louis-based CPA and business advisory firm. Wile spent more than 25 years in the metalcasting industry.
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|Author:||Herman, Adam J.; Devereux, Michael J., II; Wile, Richard L.|
|Date:||Jun 1, 2009|
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