How Risk Discovery and Mitigation Can Help Stop Future Headaches
Have you thought about how risks are discovered at your organization? Do employees understand the risks that exist within their work areas and how it impacts the overall organization?
When we’re occupied with day to day functions, we typically don’t see dangers and uncertainties lurking around the corner. These uncertainties are threats often embedded within business processes and environments that are not easily identifiable. Threats can come from sources including, but not limited to: strategic; operational; financial; legal; regulatory and compliance; credit; product/service; and natural cause/disaster risks.
The Value of Risk Assessments
One way of understanding risk is to document processes and conduct a risk assessment.
The goal of a risk assessment is to identify potential threats to the business, down to the unit level, and to understand the root cause of these risks. Then you can start a discussion on what type of risk mitigation efforts are required: acceptance as a cost of doing business, transference (insurance) or mitigation (control environment).
These activities bring you one step closer to establishing an effective Risk Management Program.
What role does one play in this risk arena? Basically, a Risk Management Program is the identification, evaluation, and prioritization of various risks, followed by an analysis and documentation of the proper courses of action.
A Six Step Risk Assessment Plan
One way to assess risk within your immediate business area(s) is by applying the following steps:
- Define your business process by creating process flows with narratives.
- Identify the potential risk areas within the process flow.
- List the controls or the lack of controls (gaps) in place.
- Create a risk ranking scale and map specific risks to your business areas.
- Have risk discussions with management to determine the risk appetite and tolerance.
- Align risks at the Enterprise Risk level. Risks should be aligned from different business areas to higher level risks (enterprise level).
Bringing Uncertainty Into A Manageable Form
Although risk management can take many forms, these initial steps will help you understand existing risks and identify potential risks. It will allow you to have a better pulse on the unknown.
The key to risk management is to bring uncertainty into a more manageable form while not disrupting the organization’s overall business goals and objectives. The better the control over a risk, the less the likelihood of an unexpected loss. A good Risk Management Program will result in meeting the business objectives of your company or organization at reduced costs.
You Need "All Hands-on Deck" for Risk Management
Organizational risks must be understood and managed by all employees. The culture of a well risk-managed business can be reflected by its people, processes, and technology and how each of those assets are deployed and dynamically related to each other. Having the proper strategic efforts within the specific business units, including transparency, and the understanding of how these risks relate to the broader organization will allow risks to be managed at the tolerance level that management is willing to accept.
Connect with a Freed Maxick Risk Management Expert
If you would like to learn more about how to minimize risk within your organization, contact one of our Freed Maxick risk professionals here, or call us at 716.847.2651 to discuss the risk services that we offer. Our risk professionals currently work with clients from multiple industry sectorsWe will work with you and your organization to complete an assessment that will identify risk, make recommendations for improving your current processes, and advise you on risk management best practices. We look forward to working with you.
A Good First Step On Your Journey To GILTI Compliance Or Avoidance
In a blog post I wrote a few weeks ago, I talked about two new international tax provisions from the Tax Cuts and Jobs Act passed in late 2017: global intangible low-taxed income (GILTI) and foreign-derived intangible income (FDII).
Since then, we’ve fielded a lot of comments and questions from taxpayers asking if they are subject to GILTI, and the analysis that needs to be done to compute its impact.
Freed Maxick’s International Tax Team huddled up and developed a very easy to use calculator that will help you begin to make this determination. In fact, all you need are two numbers from each Form 5471 that you can plug into our complimentary tool.
While we strongly recommend that you talk to your tax advisor to get more insights and guidance, this tool represents a good first step on your journey.
We’re also available for a consultation and review of your situation, without fee or obligation. Click on the button below to request a consultation, or contact Susan Steblein, CPA at (716) 847-2651.View full article
Overview of the Three Tiered BEPS Action Plan Requirements
As enterprises continue to expand operations across borders, Base Erosion and Profit Shifting (BEPS) has become a prioritized issue in international taxation. BEPS refers to the tax planning strategies of multinational entities designed to exploit differences in tax rules among mixed tax jurisdictions.
Because of insufficient reporting requirements and lack of information sharing among international tax administrations, large organizations often artificially shift profits to either low or tax-free areas where there is little economic activity and as a result, avoid taxation in high-tax jurisdictions that harbor value-added economic activity.
Overview of the BEPS 13 Three-Tiered Standardized Approach
In an effort to enhance transparency of transfer pricing documentation for various tax administrations throughout the globe, the Organisation for Economic Co-operation and Development (OECD) issued the Action Plan on Base Erosion and Profit Shifting (BEPS Action Plan) in 2013.
The guidance in BEPS Action 13 encourages countries to develop a three-tiered standardized approach to transfer pricing documentation for multinational enterprise (MNE) which include a master file, local file and a country-by-country report.
This new approach to transfer pricing documentation endeavors to ensure taxpayers remit appropriate consideration per international transfer pricing regulations and to provide tax administrations with a useful base of information that would permit an effective audit of transfer pricing practices.
The master file contains high level information pertinent to all members of the MNE group and should be made available to all relevant tax administrations. The taxpayer should exercise judgement in determining the sufficiency of detail to be reported and need not include trivial elements. Usually, the master file will include an overview of the MNE’s global operations, overall transfer pricing policies, supply chain details, main profit drivers, and primary geographic markets. Each country determines who is required to file this.
The local file should include documentation supporting material intercompany transactions of the local group member of the MNE. The local file is specific to each country and should disclose detailed transfer pricing policies, amounts involved in material related party transactions and the company’s analysis of the transfer pricing documentation relating to each transaction. Materiality will vary per country, as the taxpayer should consider size and nature of local business activity relative to the local economy.
Additionally, the local file will include information about the entity such as management structure and business strategy. Each country determines who is required to file this.
The third and last element of standardized transfer pricing documentation is the country-by-country report (CbCR) which provides information relating to global allocation of the MNE group’s income and taxes paid on a per-country basis. It also requires MNEs to report number of employees, stated capital, accumulated earnings and tangible assets in each tax jurisdiction.
Additionally, it should identify each entity within a group doing business in each jurisdiction and its respective business purpose.
Generally, the CbCR on its own does not constitute concrete evidence that appropriate transfer pricing policies have been employed and the OECD strongly recommends that tax administrations do not exclusively require this form of documentation.
Any company who has over €750M in revenues (or $850M) is required to complete the CbCR. The threshold for reporting has been set by the OECD at €750M in revenues. However, some countries have provided a translated amount in the local currency. For example, the U.S. filing threshold is $850M USD.
Variations from Country to Country
Since the release of BEPS Action 13, many countries have implemented their own versions of the BEPS Standardized Approach. Consequently, the requirements for both the master and local file vary based on the specific country the entity is operating in.
For an overview of reporting requirements of countries in North America and selected other countries, please download our complimentary Guide (no form required)
While some now require each the master, local and country-by-country report, others have merely employed the use of one or two, and some have not yet at all. Each tax jurisdiction has a minimum revenue threshold for transfer pricing reporting and it is imperative that companies be wary of these thresholds as many jurisdictions have adopted penalties to increase compliance.
Connect with a Freed Maxick International Tax Expert on Transfer Pricing Issues
We strongly recommend that you review your business operations in all jurisdictions to determine if any of these reporting requirements affect your business.
If you have any questions or concerns about how these reporting requirements may impact you, please reach out to the International Tax Team at Freed Maxick for a complementary Tax Situation Review.
Call us at 716-847-2651 to discuss your tax situation, or start the process of setting an appointment by clicking here and submitting your contact information.View full article
Can you avoid the headaches, costs, and resources needed to comply with the European GDPR regulation?
Aiming to territorially expand the protection of the data rights and privacy of people living in a European Union country, the new EU General Data Protection Regulation (“GDPR” or “the Regulation”) is one of the first global privacy laws affecting organizations all over the world.
Even though your business, nonprofit or governmental entity is US based, you may be subject to GDPR compliance requirements - and fines for non-compliance - taking effect on May 25th 2018.
As the enforceable date moves closer, US based businesses need to take a serious look at whether or not they are responsible for becoming GDPR compliant. To help you make the determination about the necessity to commit budget, time and resources for compliance, it’s important to dive into the Regulation’s Material Scope and Territorial Scope.
GDPR Material Scope
The Regulation applies to any organization that processes any personal data of an EU data subject, regardless of where the processing occurs.
The Regulation defines processing as:
“…any operation or set of operations which is performed on personal data or on sets of personal data, whether or not by automated means, such as collection, recording, organization, structuring, storage, adaptation or alteration, retrieval, consultation, use, disclosure by transmission, dissemination or otherwise making available, alignment or combination, restriction, erasure or destruction”
In comparison to the majority of the privacy laws that are currently in effect, the Regulation applies a much broader approach to what constitutes ‘personal data’. In general, most organizations view personal data to be sensitive in nature; information such as Social Security Numbers, Credit Card Numbers, or Protected Health Information (“PHI”).
However, GDPR refers to personal data as:
“…any information relating to an identified or identifiable natural person (‘data subject’); an identifiable natural person is one who can be identified, directly or indirectly, in particular by reference to an identifier such as a name, an identification number, location data, an online identifier or to one or more factors specific to the physical, physiological, genetic, mental, economic, cultural or social identity of that natural person”.
Essentially the Regulation’s requirements apply to any information that can be reasonably traced back to a specific EU data citizen.
GDPR Territorial Scope
As stated earlier, GDPR is effectively the first global privacy law. The Regulation explicitly states that it applies to the processing of personal data of EU data subjects “regardless of whether the processing takes place in the Union or not”.
It is important to note that this does not necessarily mean that processing of all EU personal data is automatically covered by the Regulation. The Regulation provides instances of where such processing would be covered.
The first instance is that the processing of covered personal data is performed by an organization established within the Union. This means that the organization’s operations are within the EU, thus any personal data processed will be covered by EU law.
The second instance is that the processing of covered personal data is performed by an organization located outside the Union, but where the processing relates to either:
“a) the offering of goods or services, irrespective of whether a payment of the data subject is required, to such data subjects in the Union; or
b) the monitoring of their behaviour as far as their behaviour takes place within the Union.”
In essence, the Regulation applies to both EU and non-EU organizations if they process covered personal data of EU citizens.
Controller vs. Processor
If your organization meets the criteria above, the Regulation views your organization as a ‘Controller’.
Controllers are organizations that interface with the data subjects, are responsible for (1) the collection of personal data from the data subjects, (2) establishing the purpose of the processing, and (3) ensuring the rights of data subjects are protected.
However, the Regulation identifies two types of covered organizations - controllers and processors. Here’s the other shoe drop: processors must be GDPR compliant also.
Processors are third parties used by controllers to perform a portion of the processing of covered personal data. Controllers are responsible for ensuring that processors provide assurance that the data subject’s rights and protections reside within their portion of the processing.
What this means is that even though an organization may not directly offer services to the EU, or meet the territorial scope requirements, they can still be required to become compliant as a processor. If your organization provides services to a data controller involving the processing of covered personal data, your organization is required to demonstrate compliance with GDPR in order for your data controllers to be able to effectively maintain their compliance.
Why GDPR Compliance Important to U.S. Businesses?
U.S. Businesses who process personal data obtained from data subjects within the Union that fail to be compliant with the Regulation face significant penalties that can include administrative fines of up to 20 million Euros or 4% of their total worldwide annual turnover of the preceding financial year, whichever is higher.
U.S. Businesses who are not compliant and provide services involving the processing of personal data to other organizations could potentially face losing business with international clients. This would be caused by the inability to support the GDPR efforts of their clientele, who are explicitly required to ensure the compliance of any processors utilized.
Freed Maxick Can Help You Become GDPR Compliant
Our team of privacy and security control experts will work with you and your organization to review your overall compliance with GDPR. By conducting a thorough examination of your organization’s privacy practices, we can help you navigate GDPR, identify weaknesses in your current processes, and advise you on the most effective and efficient ways to both achieve and maintain compliance.
Connect with us today by completing and submitting your request for a complimentary compliance assessment review, or email Peter.Schnorr@freedmaxick.com.View full article
12 Questions Taxpayers Should Ask Their Tax Advisor About New Cost Recovery Rules
How real property owners can take advantage of the latest tax minimization opportunities
If you are a real property owner, your 2017 and 2018 tax planning and return preparation will be impacted by changes to tax reform cost recovery rules resulting from thenew Tax Cuts and Jobs Act.
You’ll be faced with a few key questions related to cost recovery like whether to depreciate or expense property, whether to capitalize repairs in conformity with book treatment or expense, and whether to claim bonus depreciation or to elect not to claim bonus depreciation for any class of property – all items to discuss with your tax advisor.
We also recommend that you ask your advisor to discuss the following tax minimization opportunities – and challenges – with you:Tax Reform Impact on Section 179 Expensing
Here’s my recommendation for 3 questions about Sec 179 expensing to discuss with your CPA:
1. What affect does expensing have on the QBI deduction that applies to non-corporate taxpayers beginning with the 2018 tax year?
2. What affect does expensing have on federal or state tax credits?
- 3. When will the recapture period lapse?
Tax Reform Impact on Bonus Depreciation
Here’s my recommendation for 3 questions about bonus depreciation to discuss with your CPA:
1. Will my federal tax deduction be limited by my tax basis or the passive activity loss rules?
2. Will I owe more state tax by claiming bonus depreciation?
- 3. What impact does bonus depreciation have on renovations of existing buildings vs. new building construction?
Tax Reform Impact on Recovery Periods
Here’s my recommendation for 3 questions about recovery periods to discuss with your CPA:
Can I reduce or eliminate my current year taxable income by:
1. Reclassifying capitalized costs from 27.5 or 39-year recovery periods to 5-year, 7-year, and 15-year recovery periods, going back to 1986?
- 2. Changing the recovery periods of other tangible property that should have been assigned to a shorter recovery period?
3. Changing from depreciating to deducting the remaining tax basis in property abandoned in prior years?
Here’s my recommendation for 3 questions about passenger automobiles to discuss with your CPA:
1. Should I trade-in or sell outright?
- 2. Should I replace with a heavy truck or SUV to avoid the depreciation limitations that apply to passenger automobiles?
- 3. Will I owe more state tax if I expense or deduct the full cost of a heavy truck or SUV?
Connect with a Freed Maxick Tax Expert
In addition to changes made to cost recovery rules, the new tax act contains a wide variety of opportunities for corporate and individual taxpayers to minimize their Federal tax obligations. Click here or call our tax team at 716.847.2651 to schedule a complimentary review of your situation today.View full article
Good news for employers: eligibility, coverage and scope of the tax credit
In connection with the 2017 Tax Cuts and Jobs Act, Congress created a new tax credit for employer paid family and medical leave. Employers of all types, sizes, industries, and legal status are eligible for the credit, pending the eligibility of the employee requesting leave and in some circumstances, payments made by a State or local government’s paid leave program.
The new tax credit applies to wages paid in taxable years beginning after December 31, 2017 and before January 1, 2020.
What Does the Federal Paid Leave Tax Credit Cover?
Family and medical leave includes leave to care for the birth of a child, the adoption or foster care of a child, to care for a spouse, parent, or child who has a serious health condition, to care for the employee’s own serious health condition, or any qualified exigency arising from a spouse, parent, or child who is either on active duty, or who has been notified or called to active duty in the Armed Forces, or to care for a service member.
Unfortunately, the tax credit doesn’t apply when leave is paid by a State or local government or required by State or local law.
Starting January 1, 2018, New York State’s Paid Family Leave provides New Yorkers with job protected, paid leave to bond with a new child, care for a loved one with a serious health condition or to help relieve family pressures when someone is called to activity military service abroad. Since New York State requires participation by all private employers, the wages paid to qualifying employees are not eligible for the tax credit.
Scope of the New Family/Medical Tax Credit
For other eligible employers, the new tax credit is 12.5% of the amount of wages paid to qualifying employees while on family and medical leave provided such employee receives at least 50% of their normal wages.
A few other noteworthy aspects of the new tax credit:
- The credit percentage increases by .25% (capped at 25%) for each percentage point by which the employee is paid in excess of 50% of their normal wages while on family or medical leave.
- The amount of wages that may be taken into account in computing the tax credit is limited to a maximum 12-week period per tax year per qualified employee. The employer is required to reduce their wage deduction by the amount of the tax credit. In order to claim the tax credit, the employer must have a written policy allowing qualified full-time employees not less than 2 full weeks of annual paid family and medical leave, and a commensurate amount for part-time employees.
- To qualify, the employee must have been employed for at least 1-year before taking family and medical leave and their compensation for the preceding year cannot exceed $72,000 which is 60% of the threshold for highly compensated employees under IRC Section 414(q)(1)(B).
Got Questions? Connect with a Freed Maxick Tax Expert
This new federal paid leave tax credit is just one of the changes - many of them advantageous to employers - coming from the new Tax Act. It’s a smart move to plan for taking advantage of these changes now.
Connect with us and let’s do a complimentary review of your situation to look for opportunities and ways to minimize your Federal and State tax obligations. Call us at 716.847.2651, or complete and submit a request for a Tax Situation Review, today.
View full article
Listen to Tax Director, Don Warrant’ s take on 2 Key Changes impacting Business Owners in the Tax Cuts and Jobs Act
Freed Maxick presents three recorded interviews with Tax Director Don Warrant on issues of importance for business owners related to tax minimization opportunities resulting from the new Tax Cuts and Jobs Act.
If you own a specified service business as either a sole proprietor or as an owner of a pass-through entity, you might not benefit from a new Federal tax deduction and end up paying tax on 100% of qualified business income, instead of 80%. Hear more about this in Don’s recent interview. Listen now.
Under the new tax law, any business that meets a new $25 million gross receipts test is eligible for using the cash method of accounting. Hear Don talk about the benefits and steps you need to take now to capitalize on this opportunity and minimize future taxes. Listen now.
For your convenience, listen to Don’s treatment of both issues in this one podcast, presented in association with Entercom/WBEN’s Growing Buffalo campaign. Listen now.
Let’s Talk Taxes
Schedule a complimentary Tax Situation Review and we’ll discuss how changes to the Federal and State tax laws can affect your tax situation.View full article
Nine “Best Practices” Out, Nine New PCI DSS Mandates In
In December of 2004 Visa, MasterCard, American Express, Discover, and JCB Co. created the Payment Card Industry (PCI) Data Security Standard (DSS) to limit credit card fraud and establish a robust framework for cardholder data controls. The PCI Data Security Standard is amalgamation of the standards, requirements and guidance of each of these company’s established security programs.
Application of PCI DSS Standards
PCI DSS standards apply to all organizations that are involved with the processing, storage, or transmission of cardholder data (CHD) as well as sensitive authentication data (SAD). The Standards are divided into six major control objectives, and each control objective has twelve unique requirements representing baselines for compliance.
When Version 3.2 was released in April of 2016, many sub-requirements contained the following language, “This requirement is best practice until January 31st, 2018, after which is becomes a requirement.”
Now that these best practice requirements are compulsory, it is essential to understand how they impact your organization and the steps you must take to meet full compliance. Non-compliance may lead to the loss of the ability to process credit cards and loss of an organization’s PCI DSS compliant status.
PCI DSS Best Practices That Became Requirements in February 2018
A total of 9 “best practices” –All 9 are mandatory for service providers, including 2 for merchants – became requirements as of February 1, 2018.
If your company is seeking to become PCI compliant, or will be conducting an annual PCI DSS examination, you’ll want to make sure that compliance with these new requirements are included in your compliance program or review.
- Documenting cryptographic architecture
- Updating documentation of significant changes
- Incorporate multi-factor authentication for all non-console access
- A process for the timely detection and reporting of failures of critical security control systems
- Processes for responding to failures in security controls
- Confirming PCI DSS scope by performing penetration testing on segmentation controls
- Establishing responsibility
- Perform quarterly reviews of personnel
- Maintaining documentation of quarterly review process
- Connect with the Freed Maxick PCI DSS Compliance Experts
Our team does a significant amount of PCI data compliance work across the country, and we would welcome an opportunity to share our insights and guidance with a complimentary review of your compliance situation. We also encourage you to read our through leadership on PCI DSS or download any of our compliance related thought leadership materials.View full article
The Tax Cuts and Jobs Act signed into law by President Trump has been at the forefront of the national news since its passage in December. There are sweeping changes to the individual, business, and international taxpayers.
The Act will have an immediate and significant impact on taxpayers involved in business out of the country. For taxpayers with an ownership position in a Specified Foreign Corporations (“SFC”), the new Act requires them to pay an 8% to 15.5% “toll tax” (for individuals it could be up to 17.5%) on all deferred foreign income of these entities as of November 2 or December 31, 2017, whether a distribution has been made or not. Different tax rates are applied based on the SFC liquidity.
So how does this all work?
More About Specified Foreign Corporations
An SFC is any controlled foreign corporation (generally meaning greater than 50% US ownership) or any foreign corporation to which one or more domestic corporation(s) is a US Shareholder (generally meaning greater than 10% ownership).
This means that any US Shareholder whether a domestic corporation, partnership, individual, trust, or estate, that meets these requirements as a shareholder will be subject to this toll tax if they have deferred foreign income.
US Shareholders with interests in S Corporations that have an interest in an SFC can defer the mandatory repatriation tax as long as they make the election at the shareholder level. This election can be revoked if certain events occur.
The Basis for the New International Toll Tax: From a Worldwide to a Territorial Perspective
The Toll Tax was created by an overall change in the way international tax requirements are imposed, from a worldwide system to a modified territorial based system.
Prior to the new Act, a US person was required to pay tax on all of its income, regardless of whether it was earned in the US or in a foreign jurisdiction. However, US income tax was paid on the earnings of a foreign corporation when they were repatriated back to the US in the form of a dividend or capital gain.
This created a deferral on US income taxes for earnings of a foreign corporation between when it was earned and when it was distributed. Under this worldwide system, the US person was generally allowed a foreign tax credit to alleviate some or all of this burden.
Under the Act’s new territorial system, a US person will only pay tax on income that is earned within the United States. In most circumstance, dividends from foreign corporations will now be exempt from tax if received by a US corporation and in most other circumstances a foreign tax credit will still be available for other amounts earned in a foreign jurisdiction. In order to bridge the gap between the two international tax systems, this mandatory repatriation or “toll tax” has been put into place.
How to Calculate the Toll Tax
To calculate the “toll tax”, the US shareholders will increase their Subpart F income by the accumulated net earnings and profits of all their specified foreign entities since becoming an SFC as of December 31, 2017 or November 2, 2017, whichever is greater.
Accumulated deficits are included in this calculation to offset any accumulated earnings but not below zero. In order to arrive at the lower tax rates, 15.5% on your aggregate foreign cash position and 8% on the remainder, a deduction will be calculated at the highest corporate rate to reduce the Subpart F income included on the taxpayers’ tax return. The taxpayer is also allowed to utilize a portion of their Foreign Tax Credits to offset the mandatory repatriation tax but must also include a gross-up in its income for the amount of these taxes.
The increase in the subpart F income and correlating deduction is reported during the specified foreign entities last tax year beginning before January 1, 2018. Therefore a US Shareholder that owns a calendar year SFC will report the increase in subpart F income and relating deduction on its 2017 tax return. For fiscal year SFCs, the subpart F income and correlating deduction will be reported in its US Shareholder’s tax return in 2018.
The US Shareholder can elect to pay the “toll tax” over 8 years. The taxpayer will have to pay 8% of the “toll tax” in years one through five, 15% in year 6, 20% in year 7, and 25% in year 8. There are acceleration provision to the payment of the “toll tax” if the taxpayer fails to pay timely, in the case of a liquidation, or the sale of all of its assets.
International Tax Planning: Consequences for Your 2017 Tax Return and Obligations
Since calendar year SFCs will be reported on the US Shareholder’s 2017 tax return, taxpayers must keep this in mind if they plan on extending the due date of their 2017 tax returns. Extending the due date of filing a tax return does not extend the time to pay the tax due with the tax return.
Since one of the accelerated provisions is failure to pay timely, the taxpayer must ensure that they have timely paid 8% of their “toll tax” by the original date of the tax return, not the extended date. If they do not have their tax fully paid in it could cause the taxpayer to have to pay the entirety of the “toll tax” immediately instead of over 8 years.
Connect with a Freed Maxick International Tax Accountant
If you have any questions or concerns about how this mandatory repatriation tax may impact you please reach out to the International Tax Services Team at Freed Maxick for a complementary InternationalTax Situation Review.
If you have any questions or concerns, call the Freed Maxick international tax accountants at 716-847-2651 to discuss your tax situation or start the process of setting an appointment by clicking here and submitting your contact information.View full article
However, Startups Need to be Mindful About Future Changes to Research and Development Deductions.
Most tax experts would agree that the recently enacted Tax Cuts and Jobs Act of 2017 was generous to businesses of all types. One of the most anticipated events was what Congress was going to do with the very popular Research and Development Tax Credit.
Even though this new tax legislation made sweeping changes to the tax code, the good news is that the R&D tax credit was largely unaffected by this legislation, with the exception that start ups may have to pay income tax in earlier years than they have in the past.
Here’s a summary of Freed Maxick’s R&D Tax Credit Team’s perspective on the new legislation and its consequences for the credit:
Section 174 Costs
The most pervasive and taxpayer unfavorable provision related to research and development activities does not directly relate to IRC Section 41 (Credit for Increasing Research Activities), but rather, IRC Section 174 (Research and Experimental Expenditures).
Currently, taxpayers have the option to immediately expense R&D costs or elect to capitalize and amortize them, but starting in 2022, companies will no longer be able to immediately expense costs allowed under IRC Section 174 related to research activities. At that time, taxpayers will have to capitalize US-based research expenses to a capital account and deduct them over a five-year period.
If such expenses relate to research performed outside of the United States, they will be capitalized and deducted over a more protracted 15-year period.
IRC 280C Reduction
The definition of qualified research activities & qualified research expenses did not change, nor did the methods to calculate the credit (regular credit or alternative simplified credit).
Many taxpayers will generate larger credits as the maximum corporate tax rate decreased from 35% to 21%, thus reducing the reduction under IRC Section 280C (“280C”) or the impact of the expense addback if the 280C reduction is not elected. As you may know, you can’t claim both the credit and the deduction for research expenses. The 280C election, if made, reduces your credit by the maximum corporate rate so you don’t have to add back the deductions.
However, with the corporate rate decreasing, the benefit will decrease and the net effect on the effective rate for corporations may remain similar. Here’s an example:
Under the old rules owner’s of pass-through entities taxed at the highest individual rates and large corporations simply elected the IRC Section 280C reduction because the difference in rates was not that great for the owners (39.6% individuals; 35% corporations) and the percentage reduction (35%).
Research and Development Tax Credit Calculation
An example in the case of a large Corporation:
Corporate tax rate
R&D tax credit gross
R&D tax credit after 280C reduction
% benefit of R&D credit (Effective rate - Corporate tax rate)
A more careful analysis may be needed on individualized bases as the credit is reduced by 21% under IRC Section 280C, but the top rate could be 29.6% (assuming a full 20% QBI deduction & ignoring any affordable care act taxes).
As part of the 2015 PATH Act, President Obama exempted most taxpayers from the AMT limitation that hindered many businesses from claiming R&D credits. With the removal of the Corporate AMT starting in 2018, all corporate taxpayers will now only be limited by the regular tax limitations (taxpayers with over $25,000 in regular tax liability are limited to offsetting no more than 75% of their regular tax liability using the credit).
It is important to note that the individual alternative minimum tax was not repealed. On the bright side, with the higher exemption amount and phase-out income levels, potentially fewer individuals and pass-through entity owner/taxpayers will be subjected to the individual AMT.
Section 59A Base Erosion and Anti-Abuse Tax
The research credit is one of the very few general business credits that can be claimed to offset the new Section 59A Base erosion and anti-abuse tax (“BEAT”) tax through 2025. This tax will only impact multinationals with gross receipts over $500,000. However, those companies are highly likely to generate research credits and the R&D credits they generate can help offset this additional tax imposed upon them.
A Word of Caution for Startups on the R&D Tax Credit
After 2021, start-ups claiming the R&D Tax Credit could be in for a rude awakening. A combination of changes to the limitation on usage of net operating losses and capitalization of previously deductible IRC Section 174 costs for R&D expenditures could result in startups having to pay income tax in earlier years than they have in the past. See the discussion above related to the new Section 174 rules.
We strongly suggest that you connect with us to see how tax reform affects you or your company. The year 2022 is only a few years away, so starting to plan now may help reduce your taxable income in the future.
Connect with Our R&D Tax Credit Experts for More Information
The Research and Development Tax Credit experts at Freed Maxick are standing by to help review your situation and provide guidance on both your eligibility for the credit, and the scope and processes necessary for its capture and claim.
To schedule a complimentary review, call me at 716-847-2651, reach me via email at firstname.lastname@example.org, or simply click on the button to complete and submit a meeting request.View full article