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Summing It Up

Keeping you ahead of the curve with timely news & updates.


The R&D Tax Credit for Start-ups: There's Still Time to Claim Your Credit

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Small start-ups still have time to take advantage of a potentially major tax credit—even if you already filed your taxes for this year.

Large companies that rely on the hard sciences or use technology to create or improve products or processes may already know they can reduce federal taxes using the Research & Development (R&D) Tax Credit. The IRS has now issued interim guidance explaining how qualified small businesses can also take advantage of a new option enabling them to apply part or all of their research credit against their payroll tax liability, instead of their income tax liability.

So even if you’ve already filed your taxes, you still have time to file for an R&D credit and potentially save on your tax bill.

Before 2016, taxpayers could only take the research and development tax credit against their income tax liability. IRS Notice 2017-23 provides guidance on a new provision included in the Protecting Americans From Tax Hikes (PATH) Act.

The option for the new payroll tax credit may especially benefit your start-up if it has little or no income tax liability.

Apply Part or All of Your Research Tax Credit Against Your Payroll Tax Liability

To qualify to use all or a portion of your research and development tax credit against your payroll tax liability, your qualified small business must have gross receipts of less than $5 million and have had no gross receipts prior to 2012. This new option will be available for the first time to any qualified small business filing its 2016 federal income tax return this tax season. Those who already filed still have time to choose this option.

Your qualified small business with qualifying research expenses can choose to apply up to $250,000 of its research credit against its payroll tax liability. You choose this option by filling out Form 6765, “Credit for Increasing Research Activities,” Section D and attaching it to a timely filed business income tax return.

Extra Time To Claim the R&D Tax Credit This Year

Under a special rule for tax year 2016, a qualified small business that has filed yet failed to choose this option (and still wants to) can file an amended return to make the election by Dec. 31, 2017 (see Section 4.02 for further guidance).

After choosing this option, your qualified small business claims the payroll tax credit by filling out Form 8974, “Qualified Small Business Payroll Tax Credit for Increasing Research Activities.” This form must be attached to your payroll tax return, such as Form 941, “Employer’s Quarterly Federal Tax Return.”

Learn More About the R&D Tax Credit for Start-ups and Small Businesses

Correct assessment and filing are key factors in claiming the research and development tax credit. The right professional can help you make the most of this new opportunity. For more information on our R&D tax credit services, contact us.

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Historic Tax Credits Keep Buffalo's Renaissance Going

The Historic Tax Credit program may be the most powerful tax incentive available to fund the rehabilitation of historic properties. Don Warrant, CPA and Tax Director at Freed Maxick, talked with Growing Buffalo about how the rehabilitation of historic properties can generate a 40% cash reimbursement to property owners.

Listen to the whole conversation here, or by clicking the button at the bottom of this blog.

Interested in discussing your eligibility for the Historic Tax Credit? Call Don Warrant, CPA at 716.847.2651 or click here.

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Funding, Contracts, and the R&D Credit

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When you think of the Research and Development (R&D) Tax Credit, you might focus on the technology involved and costs incurred to create or enhance a product or process. Another important consideration though is whether the costs incurred in connection with any activity qualifying for the credit are “funded.” The essence of this requirement is to determine if the taxpayer claiming the credit has an adequate financial risk for the costs incurred and retains rights to the research results.

The tax concept of funding was essentially created to eliminate the ability for two taxpayers to claim the R&D credit on the same costs. Seminal questions to ask:

  • Who actually bears the economic risk per the contractual terms of the relationship, particularly if the project is unsuccessful? 
  • Who retains substantial rights to the research results?

Is it "Funded?"

In order for a taxpayer to be eligible for the R&D credit the related activity cannot be funded. Activity is not funded if: The taxpayer is deemed to be at risk for the costs incurred and retains substantial rights.

The questions of adequate risk and retention of rights typically arise when one party hires a contractor to perform qualifying research on a product, process, or other development.

According to the IRS, if a contractor hired to perform research for another company retains no substantial rights to the research developed under the terms of their agreement, the research is treated as “funded” to the contractor and no expenses paid or incurred by the contractor in performing the research qualify for the R&D credit. This would be the case even if the contractor was deemed to be at economic risk for the costs incurred.

Who Has the Right to Use the Research?

Retention of substantial rights does not require that the taxpayer retain exclusive rights to the research. However, a taxpayer does not retain substantial rights in the research if the taxpayer must pay for the right to use the results of the research. Basically, “substantial rights” is interpreted to mean the right to use the research.

For example, does the contract say the research is exclusive to the company that the contractor is under contract with, or can the contractor use the research and resulting technology for other companies/industries without paying royalties?

Contract Language Matters

The concept of substantial rights and risk relies heavily on specific contractual language. If a contract is poorly written, possibly neither the contractor or the company can qualify for the R&D Credit. If there is potential for significant R&D credit in connection with a contract, it is prudent to carefully review the language in the agreement and speak with tax advisors to ensure the intended party or at least one party can claim the credit.

Generally, a contractor who is paid regardless of the success of the project does not bear the economic risk and cannot claim the R&D Credit (i.e. the research is “funded” to the contractor for purposes of the credit). However, if payment will only be made contingent on the success of the efforts, then the contractor bears the economic risk and may potentially claim the credit if it also retains substantial rights to the results.

Courts have held that research expenses incurred by a contractor under fixed-price contracts were not “funded research” under the R&D credit rules because the contractor was at risk for the costs unless the project was successful. Thus the qualifying costs incurred were eligible for the R&D credit to the contractor performing the research, assuming it also retained substantial rights to the results.

Other Payment Arrangements

For cost plus arrangements on the other hand the contractor is not generally deemed to be at economic risk since it is guaranteed to be paid for its efforts. Therefore, it is not eligible for the credit. On the other hand the company paying a contractor is at economic risk and could the claim the credit on the costs paid to the contractor if this company also retained substantial rights.

Other types of contractual payment arrangements can generate costs eligible for the credit to the contractor. For instance, a cap cost-plus margin pay arrangement may allow for the contractor to claim the credit for the qualifying costs incurred. Again, the major issues are whether the taxpayer is at economic risk contingent on the success of the project and whether the taxpayer retains substantial rights to use the work, which are dependent on the terms of the contract.

Whether you are a contractor or a company using a contractor, you can maximize your chances of claiming the R&D credit in the future or allowing the other party to claim the credit by careful consideration of the contract terms. This can be a complicated issue, which can be resolved with simple solutions. Contact us for guidance.

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R&D Credit Rules for Internal Use Software Finalized

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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.

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What to Prepare for and Expect From Your First Meeting About the R&D Tax Credit

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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.

Open Communication

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.

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Time to Investigate Your Possible R&D Tax Credit

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If you rely on the hard sciences or use technology in your business to create or improve products or processes, you’re probably familiar with Research and Development (R&D) Tax Credit that can be used to reduce federal taxes by a portion of the related costs incurred.

In 2015, after 35 years of being extended over and over, the R&D credit has been made permanent—a significant change in policy that suggests a wider acceptance by the IRS of bona fide R&D credit claims.

Beginning with the 2016 tax year, your small business might qualify to claim the credit against your alternative minimum tax liability. (Qualifying small businesses include partnerships, sole proprietorships, and privately held corporations with average annual gross receipts of less than $50 million, among other conditions.) Certain eligible small businesses can also use the R&D credit against the employer’s old-age, survivors, and disability insurance liability (aka FICA taxes).

In addition, the Treasury has issued taxpayer friendly regulations that provide guidance on claiming a credit for internal use software (IUS) used principally for general and administrative purposes. R&D credit eligibility for IUS credit is subject to a higher standard and the proposed regulation provided clarity and relaxed the more stringent standards for qualification. There was also guidance that clearly acknowledged that some software development that was thought to be IUS was in fact eligible for the credit under the normal rules—for example, software design costs to improve or allow for third party interfacing.

As a result, you may have a better chance than ever of claiming the credit, one of the most generous tax incentives that the federal government offers to businesses. Now is the time to take a fresh look at your firm’s R&D efforts and your projects over the last couple of years, including software development. Any R&D activities that attempt to bring innovation into the business or its' products or services itself can be eligible for the credit.

In short, costs related to any activity that uses a technical discipline to improve a product or process may qualify. Almost any combination of using hard sciences with uncertainty as to the feasibility or design of a new or improved product or process provides opportunity to claim the federal R&D tax credit. (Note that many states also provide tax incentives for R&D activity.)

Industries That Could Benefit From the R&D Credit

Most manufacturers still don’t know they might qualify for the tax credit, which is designed to reward manufacturers who are bringing a new or improved product to market or who make the manufacturing quicker, cheaper, or greener. All types of manufacturers could be eligible for R&D credit benefits in future and prior tax years.

Similarly, many architectural and engineering firms may overlook activities that could qualify for the credit: green building design and energy efficiency innovation; structural engineering; experimenting with materials, HVAC/plumbing/electrical system designs for increased efficiencies; and high-tech equipment/manufacturing installation and design improvements.

Lastly, as discussed above, (1) software design costs to improve or allow for third party interfacing and (2) costs associated with IUS that is highly innovative may also be eligible.

The federal R&D may be a perfect financial break for your business if you know what to look for and how to navigate terms such as “Permitted Purpose” and “Elimination of Uncertainty”—in other words, the process to claim the credit.

Contact Us

We can help unravel the complexity and get you the R&D credit for your open tax years. Contact us today.

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R&D Credit Rules for Internal Use Software Clarified

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IRS proposed regs indicate that more costs may qualify for the credit than many people realized.

Rules proposed by the IRS suggest that costs a business incurs to develop software for internal use might be more likely to qualify for the Research and Development Credit than many taxpayers had previously understood. Internal use software (IUS) has always been held to a higher standard when it comes to qualifying for the R&D credit. The IRS guidance clearly suggests some software development costs that were previously thought to be IUS were in fact likely to be exempt, and it eases some requirements on software that is IUS 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, the business needs to determine if the activity relates to IUS. If it does, it must meet three additional criteria 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.

Non-Internal Use Software

On one hand, the new rules clarify that some types of internally developed software are not IUS. Software that is developed to interact with third parties or to enable third parties to initiate functions or review data on a business’ systems likely no longer need to meet the additional criteria to qualify for the R&D credit. Examples of software that no longer needs to meet the three-part IUS test include bank transaction software, delivery tracking sites, and programs that allow a customer to search a business’ inventory.

Lowering the Bar for IUS

On the other hand, the IRS made it easier to comply with the three criteria that IUS must meet in order to qualify for the credit. The new rules allow that IUS meets the innovation test if the development “is or would have been successful,” a significant relaxation on the previous requirement that the development must be successful in order to meet the innovation standard.

R&D Credit for Manufacturers - Buffalo CPA 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.

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The Research & Development Credit: Do Any of Your Activities Qualify?

It’s all about the science of innovation, no matter what your business does.

R&D Tax Credit - Buffalo CPA FirmThe Research and Development (R&D) Tax Credit has been in the news a lot lately, especially because it was made a permanent part of the tax code in a long awaited move by Congress. Until that action, the credit was included as part of a group of provisions known as “extenders” that required frequent acts of Congress to keep them available to taxpayers. As a matter of policy this is significant and may suggest a wider acceptance by the IRS of bonafide R&D credit claims. Given this newfound reliability, it’s worth a look to see if any of your business’ activities might qualify for the credit.

In short, costs related to any activity that uses a technical discipline to improve a product or process may qualify for the R&D credit. The law requires that the taxpayer use some form of hard science principle to make throughput faster and/or more efficient and that there be some doubt as to the outcome. The credit is frequently used by taxpayers to offset the costs of research designed to improve their products or certain processes.

In many cases, architectural and engineering firms may overlook activities that could qualify for the credit and reduce their tax obligation. For instance, say a cloud services provider engages an architect and an engineer to design a more energy efficient server farm. Some of their costs related to the project, notably wages, could qualify. Also, if the architect designs and tests new floor plans and wall layouts in order to improve airflow, it may be able to claim the credit for costs related to that work.

In addition, (1) software design costs to improve or allow for third party interfacing and (2) costs associated with developing internal use business software that is highly innovative, may also be eligible for the credit.

Architectural/engineering/construction costs that should be evaluated for potential R&D credit benefits include:

  • Green building design
  • Energy efficiency innovation
  • Structural engineering
  • Experimenting with materials
  • HVAC/plumbing/electrical system design for increased efficiencies
  • High-tech equipment/manufacturing installation and design improvements

R&D Credit for Manufacturers - Buffalo CPA If your business engages in activities like these, you should discuss your eligibility for the R&D credit with a Freed Maxick professional familiar with its requirements. As long as the research is based on hard science and the outcome is not certain, you may qualify for significant tax savings.

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R&D Tax Credits—New Opportunities for Taxpayers

Manufacturers will also benefit from expanded R&D tax credit benefits.

Federal tax rules have expanded in a manner that allows more activities to qualify for the research and development (R&D) tax credit and the taxes the credit can be used to offset.

More benefit from the credit means more cash available to manufacturers.

Key highlights from the R&D Credit expansion:

  • The Credit Is Now Permanent.
  • Eligible Small Businesses Can Use the Credit to Offset Alternative Minimum Tax.
  • Qualified Start-up Businesses Can Use the Credit to Offset FICA Tax.
  • IRS Noted Increasing Importance of Internal Use Software.
  • Website Design Costs for Third Party Interface.

R&D Credit for Manufacturers - Buffalo CPA For details—including examples of R&D activities, and specific New York State opportunities—download the full article from May's edition of The Bottom Line, co-authored by Freed Maxick CPAs and Tax Practice Directors, Samuel C. DiSalvo, CPA and Don L. Warrant, CPA.

Manufacturers conducting research activities should review their eligibility for federal and state level R&D credits. It is not uncommon for manufacturers to miss opportunities. For help minimizing or lowering your tax burden, contact us.

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New Opportunities for the Research and Development Tax Credit


R&D Tax Credits - Buffalo Rochester NYIn 2015, two new sets of published tax rules provided several favorable developments for U.S. taxpayers claiming the research and development (R&D) credits. Many taxpayers, including for example those who developed software interface for third parties to engage in business through the internet, could benefit from these rules.

Proposed treasury regulations, released on January 16, 2015, clarified the types of activities for developing internal use software (IUS) that are eligible for the credit. In addition, the “Protecting Americans from Tax Hikes” Act (PATH Act) enacted on December 18, 2015 established laws that promoted the ability of most taxpayers, including start-up businesses, to claim the credit.

Under the PATH Act, the following provisions were enacted into law:

  • The Credit is Now Permanent. The R&D credit, which had expired for amounts paid or incurred after December 31, 2014, was retroactively reinstated and made permanent. Fiscal year taxpayers whose tax year ended in 2015 might want to file amended returns to claim the credit for amounts paid or incurred on or after January 1, 2015, and before the end of their fiscal year.

  • Certain Small Businesses Can Use the Credit to Offset Alternative Minimum Tax. Beginning with the 2016 tax year, eligible small businesses (ESB) and their owners can claim the R&D credit against the alternative minimum tax liability. An ESB includes partnerships, sole proprietorships, and privately held corporations whose average annual gross receipts for the three-tax-year period preceding the tax year for claiming the credit does not exceed $50 million.

    R&D credits determined for a partnership or S corporation are not treated as ESB R&D credits by any partner or shareholder unless that partner or shareholder also meets the gross receipts test for the tax year in which the credits are claimed.

  • Certain Small Businesses Can Use the Credit to Offset Payroll Tax. Beginning with the 2016 tax year, a qualified small business (QSB) can elect to use the R&D credit against the employer’s old-age, survivors and disability insurance liability (i.e., FICA taxes). The election can be made for up to five tax years.

    The R&D credit is allowed to offset payroll taxes for the first calendar quarter which begins after the date on which the taxpayer files their tax return with the election. A QSB doesn’t include tax exempt organizations.

    Generally, the portion of the credit eligible to offset payroll tax is limited to the lesser of $250,000, the current year credit, or for regular corporations, the amount of the credit carryforward from the tax year determined without regard to the election.

    The credit does not reduce the amount of the FICA payroll expenditure otherwise allowed as a deduction.

    Generally, a QSB is a company that has less than $5 million in gross receipts for the current tax year and no gross receipts for any tax year before the five tax year period ending with the current tax year.

The proposed regulations on internal use software included the following guidance:

  • IRS Noted the Increasing Importance of Computer Software for Businesses. The government explicitly narrowed the application of the IUS rules to general and administrative (backroom) functions. Activities associated with IUS have a much higher threshold and by limiting their application this effectively expanded the software activities eligible for the credit.

  • Website Design Costs. Many businesses develop websites to interface with third parties which may qualify for the credit. The IRS acknowledged that certain of these costs were never subject to the much more narrow IUS rules. As a result, taxpayers may have an opportunity to claim more credit. They should review their web design/third party interface costs for prior open years and file amended returns if they determine these costs were eligible for credit under the standard, less restrictive R&D credit rules.

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