Caring for a loved one with a disability or extra needs is wrought with many challenges. One of these challenges can be how to leave assets to this beloved after your death in such a way that does not disqualify them from the governmental benefits to which they are entitled. A “special needs trust” can be one solution to this problem.
Funding Special Needs Trusts
Sometimes called a supplemental needs trust, a special needs trust is established for the benefit of a person with special needs to help him or her financially after your death. Usually established by parents for their disabled children or by children for their elderly parents, it is a vehicle by which to leave money or property behind without giving direct control over the assets. In this manner, the value of the assets in trust can be excluded from being considered in federal or state means-tested benefits of the beneficiary, thus allowing them to still receive such items as Supplemental Security Income (SSI) or Medicaid.
Several kinds of assets such as cash, real estate, business interests, stocks or intangible assets can be held in a special needs trust. Property belonging to the beneficiary can be used to fund the trust or assets from another party can be used instead, but both sources of assets should not fund the same trust, meaning there can be more than one special needs trust established for someone.
Improving Quality of Life
Collectively, these assets are used by the trustee(s) (who cannot be the beneficiary) to fund expenses that improve the quality of life for the beneficiary and that are not already covered by existing government benefits. Some examples of such expenses include:
- Additional caregiving or personal therapy, including visits to or expenses of a companion
- Reasonable expenses for experiences such as travel and visits to relatives or entertainment
- Costs for special transportation
- Personal items
The trust would pay for such expenses directly rather than the beneficiary receiving cash to pay for these expenses him or herself, which might jeopardize benefits.
Finally, a special needs trust has a finite life. It will terminate either when the funds in the trust are depleted, the beneficiary no longer needs the trust, or the beneficiary passes away.
Note that there are other avenues by which to give assets or the use of assets to your disabled loved one, one of them being a 529-ABLE plan administered by each state. However, with those plans there are limitations on the annual contribution to the plan and the total value the plan can achieve.
If you are considering one of these vehicles to improve the quality of life of someone in your life with special needs, please contact us so we can help you get started.View full article
Cash is king in the early days of a new company, and you may be able to use federal R&D credits to generate much needed cash during the initial years of your new company.
R&D and the QSB Election
The R&D credit, which rewards companies for increasing research expenditures, was permanently extended by the Protecting Americans from Tax Hikes (PATH) Act of 2015. In addition, for tax years beginning after December 31, 2015, the PATH Act allows qualified small businesses (QSBs) to elect to offset the employer portion of Federal Insurance Contributions Act (FICA) payroll taxes with R&D credits.
A QSB is a corporation, including an S corporation or partnership that has gross receipts of less than $5 million for the current tax year and did not have gross receipts in any tax year preceding the five-tax-year period that ends with the current tax year.
Start-up companies generally incur losses during the initial years of operations and are unable to use R&D credits. The QSB election allows start-up companies to use R&D credits that might otherwise go unused or are not claimed. In addition, claiming R&D credits in the initial years of operations can generate larger tax credits in future years when research expenditures increase and profits grow.
The QSB election must be made on a timely filed tax return, including extensions, and can be made for up to five tax years. A QSB can elect to apply up to $250,000 of current year federal R&D credits against their employer portion of FICA payroll tax liability beginning with the calendar quarter following the date on which the tax return is filed. Any excess elected amount exceeding the employer portion of FICA payroll tax liability is carried forward to the next calendar quarter. A QSB must also file IRS Form 8974 with Form 941each quarter.
For example, let’s say your new company is a QSB and has R&D expenditures of $25,000 per year for the first five years of operations. As a result, your new company generates $2,500 of R&D credits each year. By making the election to apply R&D credits against the employer portion of FICA payroll tax, your company enjoys $12,500 of cash savings.
Do You Qualify?
Basic questions to determine whether your company is eligible to claim R&D credits include:
- Do you have payrolled employees?
- Are you developing a new products or processes? What’s in the pipeline?
- Do you have wages associated with that development? Who’s doing the R&D?
- Do you retain rights to what you developed? To qualify, you don’t need to hold exclusive rights, just significant ones. For instance, can you take what you’re developed and apply it to your next project without anyone’s legal permission?
Related companies often use intercompany master service agreements in order to allocate common costs of doing business among the related entities. Depending on the size and nature of the business conducted, these service agreements can be extensive and include several services that are used throughout the related companies.
Something that business owners may not consider when drafting these agreements is the possibility that sales tax may need to be collected on the services provided. To complicate matters, each state has different laws that dictate whether services provided are subject to sales tax. Therefore each state that the related companies are located in should be considered in any sales tax analysis of intercompany service fees.
Sales Tax in New York
In New York State, sales of services are generally exempt from sales tax. However, services related to tangible personal property, software, and real property can be subject to sales tax and should be reviewed carefully if such services are included in an intercompany services agreement.
For example, if a service agreement includes repair and maintenance or installation services to computers, equipment, vehicles, or other tangible property, those services are subject to sales tax. License fees for access to software applications, unless specifically customized for the purchaser, are also subject to sales tax in New York State.
Avoid Costly Errors in Classification
If services related to real and tangible personal property are included in a service agreement, it is crucial to segregate these services on the invoice to the purchaser. It’s very likely that the majority of the services performed under an agreement are nontaxable due to the fact that in general most administrative services are exempt from sales tax. However, in most states, bundling both taxable and nontaxable services under a general label of “management fee” will make the entire transaction subject to sales tax. Consequently, for companies with large management fee income, an error in classification could be very costly.
If your business utilizes intercompany service agreements and has not performed a sales tax analysis, you should discuss the possible audit risks that you may face and steps to ensure proper tax filing compliance with a professional.
Freed Maxick's SALT team can assist with analysis of your service agreement to determine taxable versus nontaxable sales and review invoices for proper segregation of services to make certain that nontaxable sales do not become subject to sales tax. Contact us to get started.View full article
Be Prepared, and You Can Save Time, Effort, and Money.
If your company relies on the hard sciences or uses technology to create or improve products or processes, you might be able to reduce your federal taxes by a portion of the costs incurred using the Research & Development (R&D) Tax Credit. The credit can be significant and many types of companies potentially qualify. Smart preparation early in the process can also save you time, effort and, potentially, tax dollars.
Best Practices When Exploring the R&D Tax Credit
Reach out to qualified professionals to discuss the credit.
Find out if this professional has experience with the R&D Credit. Have they worked with companies similar to yours? They should ask about your new product(s) or innovation(s), your employees’ time associated with those developments, and if you retain rights to what you developed. Being mindful that your time is valuable, an experienced professional can often make a preliminary assessment in the first meeting as to the likelihood your company is eligible for the R&D credit or provide the preliminary questions needed in order to make that assessment.
Set up a meeting at your facility.
A walk-through helps immensely to educate your chosen consultant. That time walking through your plant or watching your prototype in action tells them a lot about your operations and, in turn, your potential to qualify for the R&D credit. Plan to set aside an hour to three hours, approximately (includes meeting time after the walk-through).
Have your subject matter experts easily accessible to discuss potential R&D activities.
These persons can be your employees or even outside contractors most connected to the development. Not having the right people involved as soon as possible in the exploratory process can negatively impact the amount of credit that you ultimately claim.
Understand that you’re trying to qualify for the tax definition of R&D.
We recently visited a manufacturing company where the chief technology officer claimed the company was doing no R&D. Of course the firm was constantly researching and developing as they were coming out with new products each year and making significant functional improvements to their existing products.
We helped him to understand that the definition of R&D for tax purposes might not match his scientific definition. This a pro-taxpayer credit: The tax definition of R&D can be more liberal and more encompassing than some traditional engineering minds might think.
That same company also experienced a year where technical challenges and other factors kept many of their developments from getting to market. They thought they had no activities to potentially quality for the R&D credit—but failure can be a positive when claiming a credit. It doesn’t mean you have no qualified R&D expenses—it can actually help show that R&D did occur.
Have your documentation ready.
Any contemporaneous documentation that monitors the activities qualifying as research activities will help to support your claim for the credit: blueprints or marketing materials, project write ups, financial information, status reports, modifications’ specs, and so on. (See our recent blog regarding proper documentation when exploring qualification for the R&D Tax Credit.)
Lack of documentation or no documentation makes the process of exploring your qualification for the R&D credit more involved; however, it is often possible to reconstruct information needed to claim the credit.
Talk to our experts today about your business’s potential to claim the R&D credit.View full article
New Rules Represent Significant Easing of Requirements on Businesses That Would Like to Claim the R&D Credit
Regulations finalized by the IRS on October 3 suggest that the costs a business incurs to develop software for internal use may be more likely to qualify for the Research and Development (R&D) Tax Credit than many taxpayers previously understood.
Internal use software (IUS) has always been held to a higher standard than other types of research when it comes to qualifying for the R&D credit. But the new IRS guidance clearly suggests some software development costs that were previously thought to be IUS were in fact likely to be exempt, and the new guidance also eases some requirements on IUS software when it comes to qualifying for the credit.
The new rules don’t change the four criteria that qualify an activity for the R&D Credit:
- It must be intended to discover information that would eliminate uncertainty concerning the development, improvement, or design of a product or business component.
- It must be undertaken to discover information that is technological in nature.
- The intended result must be useful in the development of a new or improved business component.
- Substantially all of the activities must relate to a process of experimentation.
Once an activity meets these criteria, IUS must meet three additional criteria—referred to as the high threshold of innovation test—to qualify for the credit:
- The activity must involve significant economic risk.
- It must meet a high threshold of innovation.
- No comparable third-party software is available for purchase.
The concept of IUS, because of the final regulations, is going to largely be restricted to general administrative functions, such as:
- Financial management
- Human resources management
- General day-to-day support services of your company
Clarification of the 3-Point Criteria
The IRS has made it easier and less controversial to comply with the three additional criteria above that IUS must meet to qualify for the credit. For instance, the IRS concluded that the high threshold of innovation doesn’t require that you make a revolutionary discovery or that the software development be successful.
The IUS development involves “significant economic risk” if you commit substantial resources and there is substantial uncertainty, because of technical risks, that you might recover those resources within a reasonable period. “High threshold of innovation” is defined as resulting in a reduction of costs or an increase in speed, either of which are substantial or economically significant.
The new rules, which are largely consistent with the proposed regulations, clarify that some types of internally developed software are not IUS. For example, software you might have developed to interact with third parties or to enable third parties to initiate functions or review data on your business’ systems do not need to meet the additional IUS criteria to qualify for the R&D credit. The determination of whether the software was developed for third party use is based in large part on the intention of the company at the start of the software development effort.
Examples of software that may not qualify as IUS include:
- Bank transaction software
- Software apps for a mobile device
- Software developed by a manufacturer to enable its customers to order products online
Furthermore, software developed to be sold, leased, or licensed is generally not treated as software developed primarily for internal use.
On the whole, these new rules represent a significant easing of requirements on businesses that would like to claim the R&D credit for software that they develop themselves or pay outside contractors to develop. If your business incurs costs for software development, this is a great time to take a closer look at those costs in light of the new rules to find out if you may be eligible for additional credits.View full article
The Impact of the Foreign Account Tax Compliance Act (FATCA) of 2010
Breathes there the man with soul so dead, who never to himself hath said, “This is my own, my native land.” - Edward Everett Hale, “The Man Without a Country”
Poetic and patriotic words, but the reality of today is that many U.S. citizens don’t feel this way about their native land. In 2015, 4,279 U.S. persons relinquished or renounced their U.S. citizenship, a record-breaking amount. Many analysts project that the total number of renunciations or relinquishments in 2016 will exceed the 2015 mark. To put these numbers in perspective, less than 300 people renounced their U.S. citizenship in 2006.
Looking at statistics like these, you may ask yourself: “Why are so many people giving up U.S. citizenship?” And possibly, “Is this something I should consider?”
The Foreign Account Tax Compliance Act (FATCA) of 2010 and other U.S. tax reporting regulations may have something to do with why this is happening.
A simplified explanation of the FATCA legislation is as follows:
- It is primarily aimed at preventing tax evasion by U.S. taxpayers through the use of non-U.S. financial institutions and offshore investments.
- Foreign financial institutions are required to identify accounts held by U.S. persons and report account information to the IRS. Absent this information, they are required to withhold U.S. tax on U.S. source income paid and may decline account opening or terminate services.
Furthermore, the U.S. tax system is based on citizenship. A U.S. citizen pays tax on their worldwide income no matter what country they live in.
Beyond the tax compliance burden, the financial institution impact of the FATCA legislation has significantly impacted U.S. citizens living abroad. Rather than attempt to comply with FATCA reporting requirements, many foreign financial institutions are simply refusing to open or hold accounts for U.S. persons.
To alleviate the financial hardship and tax compliance burden, many U.S. citizens living abroad have decided not to maintain their U.S. citizenship. U.S. citizenship can be terminated through renunciation. A formal renunciation of U.S. citizenship must be made in a foreign state, generally at a U.S. consulate, and there are several State Department forms to file along with a processing fee.
In addition to the paperwork and fees, the exit tax under Internal Revenue Code Sec. 877A may apply. Generally speaking, in order to avoid the exit tax you must:
- be current with U.S. tax filings for the past 5 years,
- have had annual U.S. tax liabilities below $160,000 for those 5 years, and
- a net worth of less than $2,000,000.
If you find yourself in the situation where you are considering renunciation of your U.S. citizenship, there are planning opportunities and compliance requirements that must be considered. Contact Freed Maxick's International Expatriate Tax Services professionals to discuss your specific situation, or call to speak with an individual directly at 716.847.2651.View full article
Did your company develop any new products for the year? Make significant enhancements to products or processes? If you’re in financial management in any way in your company, you owe it to yourself and your firm to investigate if you qualify for the Research & Development (R&D) Tax Credit.
If you rely on the hard sciences or use technology in your business to create or improve products or processes, you might be able to reduce your federal taxes by a portion of the related costs incurred.
Investigating your eligibility for the credit includes an initial meeting with an R&D credit expert. What should you prepare for your initial meeting? Expect to be able to provide the following:
Access to Key Personnel Who Were or Are Involved in the R&D Activities
This might be one person or multiple individuals depending on your company size. In bigger companies, a team approach can often foster a better discussion, bringing ideas together and identifying other areas where one or more individuals in the company might be engaged in R&D activities.
Your key personnel must be available for meetings and interviews, and should also be able to identify who performed R&D-type work during the year and be able to assist in quantifying their time spent in this work. The identification should include both internal resources (employees) and external resources (outside contractors).
We have had great success with three to five attendees in these meetings with our clients, often one person from finance and others from the R&D activities.
Internal Documentation Concerning Your R&D Activities
Any contemporaneous documentation that monitors the activities qualifying as research activities will help to support the claim for the R&D credit. The more you can share the better—it’s less documentation that we the consultants have to do, and it will reduce the time R&D personnel spend with us on interviews and in other meetings. Examples might include blueprints or marketing materials, project write ups, status reports, modifications, etc. Detail highlighting unique features of your R&D is also generally very helpful. A product catalog with only pictures won’t be sufficient enough to stand on its own.
We understand that you probably won’t have all of this information at the initial meeting, but the more you have the better. As the R&D study progresses, we will work with company personnel to complete the information.
Your documentation should include financial information. Wages (box 1 of Form W-2) is usually the most important part of your potential R&D credit financial information. This includes wages paid to employees directly involved in R&D and employees in direct supervision or support of R&D.
Recording of your R&D activities to separate accounts is helpful. For example, bifurcating R&D material and supplies (property eligible for depreciation is excluded) and non-R&D materials and supplies saves time and effort at year’s end when calculating the credit.
The same point holds true regarding separate accounts for outside contractors for work in any of the four parts. In addition, copies of contracts with outside contractors showing who retains rights is important. As this can be a significant expenditure for many companies, copies of your larger contracts also help at initial meetings.
If you use a job-time tracking system, codes to signify R&D work vs. non-R&D work will assist in determining the project list and qualifying costs at the end of the year. If you don’t use a job-coding system, each eligible employee should keep a list of projects that may qualify for the R&D credit. (Some companies keep a simple Word document to track monthly R&D-related financials.)
If you find you need to retrofit your internal R&D documentation, you can begin to go back and build the records with a list of projects that your teams worked on that you believe are R&D. You will also need a list of employees in R&D with reasonable estimates of how much time they spent on the R&D projects, along with any other materials or outside contractor costs.
After our initial meeting all parties should practice timely follow up to questions, within a week generally. There must also be full disclosure of activities, especially work performed within the U.S. versus outside of the U.S. Only the former can qualify for the R&D credit.
Talk to our experts about your business' potential to claim the R&D credit today.View full article
Avoid potential tax ramifications in both the U.S. and Canada.
The United States has some mechanical rules for determining if one will be considered a resident for tax purposes.
Two Ways You Could Be a U.S. Resident
First, if you receive a Green Card, you will be granted the privilege of residing permanently in the U.S. as an immigrant. This will continue until either you surrender your Green Card or immigration authorities revoke it. As long as you hold a Green Card, you are required to file U.S. resident tax returns.
The second qualifying condition is if you meet the Substantial Presence Test. This is basically a 183-day of presence in the U.S. test—however, it's cumulative. You are considered a resident if you are physically present in the U.S. for at least 31 days in the current year, and the sum of the days in the current year plus 1/3 of the days physically present during the first preceding year, plus 1/6 of the days present in the second preceding year exceeds 183 days. (There are certain situations that allow an exemption of days for students, those in transit, commuters, and days spent for medical purposes.)
You must file a Form 8840 or Form 8843 and either attach it to your 1040NR or you may file it alone. These forms will exempt a non-U.S. citizen who meets the substantial presence test from being treated as a resident. They cannot be used by a Green Card holder.
There are also Treaty Tie Breaking Rules. Under Article IV of the U.S./Canada Treaty, there are several steps that you can follow to establish that even though you are present in the U.S. for over the required number of days, you actually have a closer connection to Canada. You must file a Form 8833 and disclose your position.
If it is determined that you are a resident of the U.S. for tax purposes, you will be taxed on Worldwide Income, regardless of where it is earned. You will also be required to file any of the Foreign Reporting Forms required of U.S. persons, such as FBARs, and Forms 8938, 5471, 8865, 8621, and 3520, to name a few.
If you are determined to be a non-resident, you are taxed on U.S. Source Income only. However, if you are taking a Treaty Position to be taxed as a non-resident, you are still required to file all of the reporting forms as named above.
Canada also has established consequences for being out of the country for too long. The Entry-Exit Initiative was due to be implemented June 30, 2014. This does not have a temporary stay at the moment. Under the Initiative, travelers will be required to swipe their passports upon entering and leaving each country. Canada and the US will share this information. Both countries remain dedicated to full implementation of the Initiative.
When fully implemented, this Initiative would allow both countries to be able to track, in real-time, the number of days actually spent in each country. All days are counted in this total, including days for work, vacation, and day trips for shopping or entertainment.
Once a Canadian resident loses his resident status, he is deemed to have disposed of his assets, which may generate a large tax bill. They may also risk the loss of the entitlement to Provincial Health Care. The time period out of the country depends on your Province of Residency.
In addition to being deemed a U.S. Resident for Income Tax purposes, a person's estate could also become liable to U.S. Estate tax.
A Word to the Wise
Use extreme caution on counting the number of days of presence in the U.S. Generally, snowbirds should not extend their time past 120 days per year. Under the cumulative test, 120 days consistently will bring you to 180 days over a three year period. You do not want to risk consequences from either country by exceeding this number.
Contact Freed Maxick's International Corporate Tax Services professionals to discuss your specific situation and avoid unexpected tax liabilities, or call to speak with an individual directly at 716.847.2651.View full article
The complexity of state and local sales and use tax is a problem in every state and for many businesses. Each jurisdiction has a different rule on the taxability and exemption of a particular product or service. For instance, downloaded computer software (that isn’t customized) is considered taxable in New York, but not taxable in California. Payroll services are subject to sales tax in Texas as a data processing service, but this service is not considered taxable in Pennsylvania or New York.
It continues to be a growing problem in an ecommerce world for businesses, especially small businesses, to stay compliant with each state’s regulations and to identify overpaying sales tax. In addition to the complexity of sales and use tax, states continue to broaden the taxability of transactions and audit businesses in order to raise more revenue. As such, businesses are likely to err on the side of caution and pay unnecessary sales tax on purchases or charge customers who are exempt. A company should evaluate the complexity and volume of their sales and use tax transactions to determine if there’s a remote possibility that the company is overpaying sales tax.
Reverse Sales Tax Audit
A reverse sales tax audit is a thorough analysis of a business in order to identify the overpayment of sales and use tax. A state and local sales tax consultant will evaluate your company’s business operations, fixed assets, and how you are paying and charging sales and use tax.
Generally, the first step is an evaluation of the purchasing function within your business in order to obtain an understanding of how purchases are being made and approved. Once the consultant has analyzed the business processes and purchasing methods, a sample of paid invoices will be reviewed for sales tax that was charged on exempt items and for the incorrect sales tax rate that may have been applied. Once a quantitative analysis has been completed, the appropriate documentation and information will be delivered to the state or vendors to recover the overpaid sales tax.
It’s also imperative to have an analysis performed on invoices to your customers. In today’s competitive global market, the ultimate decision of a customer could be based on the price of your product or service. Therefore, it’s vital for a business to know who they are selling to and whether the customer is subject to sales tax in their jurisdiction. Generally, a similar approach in reviewing the purchasing functions would be used on the company’s sales functions.
If you’ve had a reverse sales tax audit performed in the past, opportunities may still exist. State tax laws and exemptions are always changing and these changes could be overlooked by your company. In addition, having a reverse sales tax audit performed in conjunction with a major capital project underway can save tax dollars promptly by avoiding the payment of sales tax on purchases of equipment, supplies, etc. that could be exempt.
If your business engages in manufacturing activities or purchases and sells across multiple jurisdictions, you should discuss a reverse sales tax audit with a Freed Maxick professional from the SALT team. Contact Freed Maxick's professionals to discuss your specific situation, or call to speak with an individual directly at 716.847.2651.View full article
What you need to know as a nonresident who sells U.S. real property interests
If you are selling a piece of U.S. real estate, you may have a tax withholding obligation to the purchaser. The FIRPTA rules require that buyers of U.S. real property know the residency status of whoever is selling the property for reasons explained below.
FIRPTA requires that a purchaser of U.S. real property withhold tax on the gross sale price if the seller is a non-U.S. person. Real property for these purposes is either a piece of real estate or a corporation that holds real estate. A non-U.S. person for this purpose includes all foreign persons and foreign entities selling or transferring property located in the U.S. Any withholding tax owed (including interest) that isn’t remitted becomes a liability of the purchaser.
FIRPTA Withholding Rate Increase
As of February 2016, the FIRPTA withholding tax rate has increased to 15% from the previous rate of 10%. The tax is calculated based on the gross sales price with no consideration for the actual gain or loss. As a result, even on a loss transaction, foreign real property sellers are looking at the potential of a 15% tax withholding from the gross proceeds.
As an example, assume (as a foreign person) you sold a piece of real estate on June 1st for $1,000,000. The purchaser would be obligated to withhold $150,000 of the sale price and remit this to the IRS. This is true regardless of what your basis in the property was at the time of the sale. However, it is possible to request a reduced rate of withholding in advance of the closing to reduce or possibly eliminate this withholding. This can save a substantial amount of money, as any tax that isn’t owed but is withheld would not be available for refund until the following year upon filing a tax return.
There is a process by which you can apply for an exemption from or reduction to this mandatory withholding. Form 8288-B can be filed on behalf of the seller. As long as this form is filed by the date of closing, the purchaser will not be required to remit the withholding tax until notified the form has been processed by the IRS.
- Any purchaser of a U.S. Real Property Interest (USRPI) should be aware of the seller’s U.S. residency status.
- If you are a foreign seller of USRPI, the purchaser will withhold and remit 15% at settlement unless you apply for a withholding exemption.
- There are exceptions from the withholding rules. For example, if the gross sales price is $300,000 or less and the purchaser intends to use the property as a residence, there is no withholding required.
- All of this is in an effort to reduce the amount of withholding up front prior to filing of the tax return by the seller.
We at Freed Maxick have vast experience with these and other international matters. Please contact us if you have any questions.View full article