A discussion of Qualified Opportunity Fund (QOF) benefits, eligibility requirements, and action steps
The Tax Cuts and Jobs Act of 2017 (TCJA) created a new tax incentive program for taxpayers to defer capital gains tax by investing in certain economically distressed areas known as “Opportunity Zones.”
Tax Director Don Warrant Speaks Out on Opportunity Zone Opportunities. Listen here.
Qualified Opportunity Zones (QOZ) are areas nominated by the governors of U.S. states and territories based on Census data that identify low-income communities. A map of the communities can be found on the U.S. Treasury’s CDFI Fund web page.
At this point, the maximum number of eligible zones has been nominated by each state and the current law does not allow for additional or revised designations, even if future census data might suggest that the boundaries have shifted. In other words, the universe of Opportunity Zones has been determined and is expected to remain stable unless the law changes.
Opportunity Zone Investment Program Tax Incentives
The Opportunity Zones program tax incentives include deferral of capital gains tax from the sale or exchange of assets with unrelated persons and capital gains tax exclusion. To access the tax incentives, taxpayers (including corporations, partnerships, individuals, estates and trusts), have a 180 day period in which to reinvest capital gain proceeds in a Qualified Opportunity Fund (QOF). The beginning of the 180 day period varies based on the type of taxpayer and the classification of the gain as capital or section 1231.
The Opportunity Zone tax incentives are as follows:
- The capital gain that would have been recognized in the year of the sale is deferred until the QOF investment is sold or exchanged, or until Dec. 31, 2026, whichever is earlier;
- 10 percent of the deferred capital gain is permanently excluded from federal taxable income after holding the QOF investment for 5 years;
- An additional 5 percent of the deferred capital gain is permanently excluded from federal taxable income after holding the QOF investment for 7 years; and
- Any appreciation in the QOF investment is permanently excluded from federal taxable income after holding the QOF investment for 10 years.
How to Make a QOF Investment
To make a QOF investment, taxpayers must first generate a gain from the sale or exchange of assets that will be treated as a capital gain for federal income tax purposes. The federal income tax treatment of a net section 1231 gain is not determined until the last day of the tax year. Capital gains must be invested in a QOF within the required 180 day period.
The tax incentives apply to the portion of capital gains that are timely invested in a QOF. Any investment of non-capital gains are treated as a separate investment by the QOF since they don’t qualify for the tax incentives.
A QOF is an entity organized as a corporation or partnership for the purpose of investing in QOZ property (other than another QOF). The QOF does not need to be located in an Opportunity Zone. However, at least 90 percent of the QOF’s assets must be QOZ property for substantially all of the QOF’s holding period of such assets. QOZ property includes QOZ stock, QOZ partnership interest, and QOZ business property.
The QOZ stock or partnership interest must be acquired by the QOF after Dec. 31, 2017 for cash provided the entity is a QOZ business, or is being organized as a QOZ business. Alternatively, the QOF may acquire QOZ business property.
Taxpayers who are considering a real estate development project located in a QOZ or considering the operation of a business located in a QOZ can establish their own QOF. Alternatively, taxpayers seeking the tax incentives provided by the Opportunity Zones program can invest capital gain proceeds in a QOF that is professionally managed by others. In that case, taxpayers should perform the appropriate amount of due diligence before making the investment to assure the investment will operate as required in accordance with the program rules.
When to Make an Opportunity Zone Investment
The tax incentives provided by the Opportunity Zones program are based in part, on satisfying a 5 year, 7 year, and 10 year holding period. Under the rules, any QOF investments made after Dec. 31, 2019 are not eligible for the additional 5 percent capital gain exclusion since the investment will not be held for 7 years by Dec. 31, 2026.
Likewise, any QOF investments made after Dec. 31, 2021 are not eligible for the 10 percent capital gain exclusion since the investment will not be held for 5 years by Dec. 31, 2026.
Otherwise, taxpayers can obtain capital gains tax deferral by making a QOF investment at any time before Dec. 31, 2026. On Dec. 31, 2026, the lesser of the fair market value of the QOF investment or the deferred capital gain, reduced by the tax basis in the QOF investment, is recognized. Taxpayers will need to plan accordingly for this tax payment.
Taxpayers can continue to hold their QOF investment after Dec. 31, 2026 (and through Dec. 31, 2047). Under the rules, gain on the sale of the QOF investment after 10 years is excluded from federal taxable income and potentially state taxable income.
Freed Maxick Provides Opportunity Zone Consulting
If you own appreciated assets that would result in a capital gain upon sale or exchange with an unrelated person, then you may be a candidate for a QOF investment. The Opportunity Zones program experts at Freed Maxick can assist in comparing a fully taxed investment to a QOF investment.
In addition, a proposed Opportunity Zone business or real estate development project should consider the other Federal, State and Local tax credit and incentive programs that are available. Consultation with professional tax advisors knowledgeable in these programs could significantly increase the return on investment.
Freed Maxick provides advisory, tax planning and reporting services for both investors and fund sponsors considering involvement in the Opportunity Zone program, Click on the image to schedule a complementary Tax Situation Review, or contact Don Warrant, CPA at 716-332-2647 for consultation regarding the Opportunity Zones program.View full article
April 15 is usually a happy day for tax practitioners and taxpayers alike. April 15, 2019 was not a happy day for Siemer Milling Company and their tax advisors after Siemer Milling Company v. Commissioner (TC Memo 2019-37) was decided. This case focused on seven projects the company claimed the R&D tax credit on in 2011 and 2012.
Here’s a summary of Freed Maxick’s R&D Tax Credit Team’s perspective on this case and its consequences for the credit:
R&D Tax Credit documentation is KEY.
As you can see from the chart below, ALL seven projects reviewed were denied as Siemer Milling Company was not able to prove they engaged in a process of experimentation (and in some instances other parts) of the 4-part test.
The big takeaway from this case is that it reinforces the fact that documentation is vital to the successful claim for R&D tax credit. IRS stated that “the record is devoid of evidence that petitioner formulated or tested hypotheses, or engaged in modeling, simulation, or systematic trial and error…” Unfortunately for the taxpayer, the Tax Court agreed and denied each project!
Based on the results of the case, three of the seven projects would appear to have qualified for credit (#’s 1, 4 and 7 in the chart above) if there was sufficient documentation to a process of experimentation.
Key takeaway…document, document and document!
Siemer down, it wasn’t all bad for other taxpayers!
The IRS took draconian positions in a few areas that the Tax Court summarily shut down!
- Uncertainties - IRS asserted that Siemer could not face the same uncertainty for more than one year. The tax court responded that this argument was unpersuasive and that Siemer “could have faced the same uncertainties for several years in a row and not all uncertainties are neatly resolved within the confines of a single taxable year.”
- Education - IRS asserted that Siemer could not have engaged in R&D activities as they did not employ anyone with the title of engineer or anyone with an engineering degree. The tax court responded that this argument was unpersuasive and that nothing requires a taxpayer to employ or contract with someone with a specialized degree to prove that research relied upon physical or biological sciences, engineering, or computer science.
- Multiple tax periods - IRS asserted that Siemer could not have “new” projects for more than one year. The tax court responded that this argument was unpersuasive and that “the development or improvement of a business component can span more than one tax year.”
Uncertainties and projects themselves spanning multiple tax periods is VERY common. Not only could projects that start very late in a year continue into the subsequent year, some projects are very complicated and time consuming, which could result in the project spanning more than two tax periods. We agree with the courts argument that this is unpersuasive and doesn’t have any standing in the legal statute or case law.
While education may be very important for a taxpayer’s employees to perform their function, there is no statute or legal requirement that a skilled tradesmen (or anyone else for that matter) without a formal education isn’t performing R&D for a taxpayer. You have to look at the ACTIVITY not the EDUCATION of the individuals engaging in R&D.
Key takeaway…it is the activity that matters, not when or how it is done!
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.
For more insight, observations and guidance on the R&D tax credit, click here.View full article
Listen to Freed Maxick tax directors describe the “must know” news for business owners
There are a significant number of new rules and opportunities for business of all kinds and sizes to minimize their Federal taxes as a result of the Tax Cut and Job Act. One year later, we’re happy to present these recorded interviews with Freed Maxick Tax Directors, Bill Iannarelli and Don Warrant discussing aspects of the new Tax Cuts and Jobs Act that business owners need to know.
In this recorded interview, Bill talks about how the new Act allows for the full expensing of real property placed in service after 9/27/17, and expanded definitions of qualified real property. Listen now.
Bill discusses the 20% tax pass through for domestic qualified income for selected business types in this recording, including eligibility requirements and specific exclusions. Listen now.
Bill presents his observations and insights on changes made to entertainment expensing – what’s in, what’s out and what employers need to know about providing meals to employees. Listen now.
In this interview, Don talks about two important changes: businesses having more opportunity to expense assets in the year of purchase, and the ability of some business owners to reduce their taxable income by 20%. Listen now.
Don describes an opportunity for real estate investors in opportunity zones to defer Federal taxation of capital gains until 2026. Listen now.
Connect With Us
If you would like to discuss how Federal and State changes to tax codes affect your situation, please call the Freed Maxick tax team at 716.847.2651 to schedule a complimentary Tax Situation Review. Or, click on the button, give us your contact information, and a member of our staff will connect with you to schedule a discussion.
For more insight, observations and guidance on the new Tax Cuts and Jobs Act, visit our Tax Reform webpage.View full article
Advantageous Tax Accounting Method After Tax Reform May be Available
The Tax Cuts and Jobs Act of 2017(TCJA) included many headline-grabbing changes for businesses like the lower corporate rate and the 20 percent deduction for pass-through. One important provision that hasn’t gotten as much coverage is a change to tax accounting rules for small businesses that will allow more growing small businesses to qualify for smaller tax bills.
For tax years beginning after December 31, 2017, business taxpayers with annual average gross receipts for the last three taxable years of less than $25 million now qualify to use the cash method of accounting when calculating taxable income. This increases the limit from the pre-TCJA cap of $ 5 million over the same period.
Taxpayers who might qualify for the new higher threshold need to re-evaluate their accounting methods, as a switch to the cash method can potentially yield an immediate tax benefit.
Eligible businesses that have been using the accrual method but now want to switch to the cash method will need to file an accounting method change Form 3115 with the IRS to switch to the cash method of accounting. An accounting method change and Form 3115 are filed by the due date (including extension) of the tax return for the year of change.
Changing from accrual to cash-basis for tax purposes
A switch to the cash method of accounting can result in significant tax savings for a business if:
- Accounts receivables and prepaid expenses are greater than
- Accounts payables, and accrued expenses.
Businesses will need to analyze these balance sheet items to determine if the cash method of accounting creates a favorable adjustment in the current year. When making an accounting method change, the law requires the taxpayer to calculate an adjustment amount for items on the opening balance sheet for the year of change. A net positive adjustment is absorbed into taxable income over the next four years; a net negative adjustment is claimed as a deduction in the year of change.
The illustration above would result in a favorable tax deduction of $390,000 in 2018. What does this $390,000 deduction mean from a tax savings perspective? In our example, the accrual to cash adjustment will save the taxpayer an estimated $81,900 of Federal Income Tax ($390,000 x 21 percent tax rate) in the year of change. As you can see, the method change can provide the most significant value in the first year.
Cash-basis Accounting Method
Companies that use the cash-basis method of accounting for tax purposes recognize revenue and expenses when the money comes in and goes out. Cash-basis entities generally have opportunities to postpone revenue recognition and accelerate payments at year-end. Under the cash basis, expenses are deductible even when a line of credit or other credit facility is used to pay expenses/invoices. This strategy can temporarily defer the company’s tax liability.
For smaller businesses, the cash method of accounting for tax purposes provides a more accurate reflection of cash flow and does a better job of matching revenues with the corresponding tax liability in the year that the cash is actually received. Although the taxpayer will remain on the accrual basis for GAAP and financial statement purposes, switching over to the cash basis for tax reporting changes the year-end tax planning conversation and strategy.
What happens if the taxpayer exceeds the $25 million in a future tax year?
Eligibility is determined annually based on the average gross revenues for the prior three years. If a taxpayer’s average gross revenues exceed $25 million in the future, the taxpayer will be required to switch back to the accrual method. The deferred income related to that change is added back over a four-year period, similar to the adjustment described above.
The sooner you change to cash-basis, the longer you benefit
The TCJA widens the pool of eligible taxpayers who qualify for the cash method of accounting. In order to take full advantage of the provision, businesses should act quickly to determine if they benefit from the cash method and file the necessary election with the IRS to implement the change as soon as possible.
To learn more about changing from accrual to cash-basis for tax purposes, whether your business qualifies and how it might benefit, please call the Freed Maxick Tax Team at 716-847-2651 to discuss your tax situation, or complete and submit the form to schedule a complimentary Tax Situation Review..
For more insight, observations and guidance on the new Tax Cuts and Jobs Act, visit our Tax Reform webpage.View full article
Real property owners and developers often consider the federal Historic Tax Credit (HTC) when evaluating whether to acquire and substantially rehabilitate historic buildings. Unfortunately, the Tax Cuts and Jobs Act (TCJA) repealed the 10% federal HTC and modified the 20% federal HTC. These changes, which are effective for taxable years beginning after 2017, will likely impact the acquisition and rehabilitation of historic buildings.
Repeal of the 10% HTC
Before the TCJA, taxpayers could claim a 10% federal HTC for expenditures paid or incurred to substantially rehabilitate non-certified pre-1936 buildings. Unfortunately, the TCJA repealed this provision.
Modified 20% HTC
Before the TCJA, taxpayers could claim a 20% federal HTC for expenditures paid or incurred to substantially rehabilitate a certified historic building. The 20% federal HTC continues, but the timing for claiming the federal HTC has changed.
Before the TCJA, the federal HTC was claimed for the taxable year in which the certified historic building was placed in service after substantial rehabilitation. A “certified historic building” means a building which is listed in the National Register of historic places, or is located in a registered historic district and certified to the Secretary of the Treasury by the Secretary of the Interior as being of historic significance to the district.
The TCJA modified the timing for claiming the 20% federal HTC. Under the new rules, the federal HTC is claimed ratably over a 5-year period beginning with the taxable year in which the certified historic building is placed in service after substantial rehabilitation. This change impacts the overall return on investment for the rehabilitation of certified historic buildings.
In addition, excess federal HTCs generated for the taxable year in which the certified historic building is placed in service after substantial rehabilitation will diminish. Excess federal HTC’s means HTC’s exceeding federal income tax liability for the taxable year in which claimed. Such excess HTC’s may be carried back to the immediately preceding taxable year by filing a carry back claim resulting in a refund of federal income taxes paid in the preceding tax year. However, under the new rules, the ability to generate excess HTCs will diminish.
Listen to a podcast from Freed Maxick Tax Director Don Warrant on how the Historic Tax Credit can generate 40% cash reimbursement for property owners.
The TCJA provides a transition rule whereby the changes made by the TCJA do not apply to expenditures paid or incurred by the end of the taxable year in which the 24-month period, or 60-month period, ends when the following two conditions are met:
- The building was owned or leased during the entirety of the period after December 31, 2017, and
- The date of the beginning of the 24-month or 60-month period is no later than June 20, 2018.
The 24-month period and the 60-month period are in reference to the period over which the certified historic building must be substantially rehabilitated.
Under this transition rule, all expenditures should be paid or incurred by the end of the taxable year in which the 24-month or 60-month periods end.
Tax Basis Reduction Rules
The TCJA did not affect the rule that requires the tax basis of the certified historic building to be reduced by the amount of the HTC claimed. Generally, tax basis reduction rules don’t apply when federal tax credits are claimed over multiple tax years. Fortunately, a bipartisan group of House and Senate lawmakers introduced legislation that would eliminate the rule that requires the tax basis of the certified historic building to be reduced by the amount of the HTC claimed. However, no further action has been taken on this legislation as of the time of this writing.
States that follow the federal HTC rules may adopt the changes made by the TCJA or decouple from those changes.
For example, New York State provides a refundable HTC equal to the amount of the federal HTC. However, New York State has decoupled from the changes made by the TCJA. Therefore, taxpayers can continue to claim the 20% New York State HTC for the taxable year in which the certified historic building is placed in service after substantial rehabilitation.
For Further Clarification and a Discussion of Your Situation
The Freed Maxick Tax Team has significant experience when it comes to helping real property owners and developers qualify for and claim historic tax credits as well as other Federal and state tax credits. With an ever-changing tax landscape, our team is prepared to assist real property owners and developers to minimize their income tax liabilities using the various tax credit and incentive programs, and other tax minimization strategies.
For more information on how the changes made by the TCJA might impact your historic rehabilitation project, or to discuss other changes made by the TCJA, please call us at 716.847.2651 or contact us here.View full article
How to determine the correct transfer pricing strategy for your business in the new tax environment
On December 22, 2017, the federal Tax Cuts and Jobs Act (“The Act”) was signed into law creating one of the largest tax overhauls in history. Though there were no direct changes to the transfer pricing requirements, certain international provisions implemented through the Tax Act may create an impact on transfer pricing.
These provisions include, but are not limited by, Foreign-Derived Intangible Income (“FDII”), Global Intangible Low-Taxed Income (“GILTI”), Base Erosion Anti-Abuse Tax (“BEAT”), and the definition of intangible property. It is important that companies review their existing transfer pricing policies or take these provisions into consideration when creating a new policy to ensure that they comply and maximize all tax planning opportunities.
Foreign-Derived Intangible Income (“FDII”) & Global Intangible Low-Taxed Income (“GILTI”)
The FDII provision of The Act creates an incentive for U.S. corporations that sell, lease or license intellectual property to retain their assets in the United States by providing a preferential tax rate on that foreign-derived income. Thus, with a special rate of 13.125 percent, a domestic corporation with foreign affiliates might find it advantageous to shift intangible leasing profits into the United States.
As the counterpart to FDII, The Act’s provision on Global Intangible Low-Taxed Income was designed as a safe-guard to combat a U.S. corporation’s attempt to shift profits overseas to take advantage of the new territorial system. Briefly, GILTI imposes penalties on organizations that derive income from foreign intangibles harbored in low-tax jurisdictions. The tax subjected could render a territory less advantageous when contrasted to pre-tax reform.
A U.S. corporation should consider FDII and GILTI in determining which taxing jurisdiction to house its intangible assets. Tax incentives to source profits to the U.S. include lower rates and avoiding penalties which might outweigh the tax benefits of foreign sourcing going forward.
With the above provisions affecting the tax of intangible assets, it is relevant to note that the definition of intangibles has also been amended with The Act to include anything with potential value that is not attributable to tangible property. Further, valuation of intangibles has been challenged with The Act, giving the IRS the authority to value transfers of intangible assets on an individual basis, in the aggregate, or by any other means deemed reasonable. The modification of the definition itself could potentially diminish the reliability of existing transfer pricing policies and the wording of said policies should be reviewed.
Base Erosion Anti-Abuse Tax (“BEAT”)
BEAT is an additional tax that applies to corporations that have average annual gross receipts of $500 million and have foreign deductible related-party payments totaling at least 3% of the sum of all annual deductions. The tax is computed as a multiple of the sum of the corporation’s taxable income and the deducted foreign related-party payments. Although BEAT does not apply to all related-party payments, susceptible corporations should be wary of large base erosion transactions that are material to total deductions going forward. The adverse cost of BEAT could perhaps outweigh the advantages of transacting with foreign affiliates.
Assessing the Impacts on Your Company’s Transfer Pricing Strategies
With all of the above provisions being effective January 1, 2018, now is a good time to assess their impact on your transfer pricing strategy and policies. If you have not done this already, there are still plenty of transfer pricing planning opportunities that can be utilized for the 2018 tax year.
The International Tax team at Freed Maxick CPAs, P.C. has been monitoring these provisions closely and is ready to discuss how your business may be impacted. Connect with us to schedule a Tax Situation Review so we can provide guidance on how to maximize planning opportunities and optimize your transfer pricing strategy.
You can reach us at 716.847.2651 to schedule a review today.View full article
New Tax Law, Same Old Question: What’s the Best Entity for Your Business
The Tax Cuts and Jobs Act of 2017 (TCJA) made some of the most consequential changes to business income taxation in decades. With a new, significantly lower and flattened corporate tax rate, reduced personal rates, and a 20 percent deduction for income from flow-through entities, the act altered several variables in the equations that executives use to determine the most tax-efficient structures for their businesses. As a result, many leaders are asking how to re-evaluate the choice of entity and what amount of tax advantage warrants such a fundamental change. There are no simple answers to these questions, but this discussion provides a quick overview of some of the key criteria.
The “Simple” Math of Business Entity Choice
Many executives are surprised to learn that the new tax rates and the 20 percent deduction are actually some of the less complicated factors to analyze in a choice-of-entity re-evaluation. Here’s a quick review of C-corporation v. flow-through taxation and the effect of the new law on each:
- C Corporations pay an entity-level income tax and income distributed to shareholders is taxed again at the individual level.
The TCJA significantly decreased the corporate tax rate from a top marginal rate of 35 to 21 percent. As a result, a sole shareholder of a C Corporation that distributes all of its after-tax earnings would face an effective federal income tax rate of approximately 39.8 percent.
- Flow-through entities are not subject to federal income tax at the entity level. All income generated from the business is reported and taxed on the owners’ individual income tax returns.
TCJA did reduce the tax rates on individuals, but the drop was not as significant as the reduction in corporate rates. Top earners went from a maximum rate of 39.6 to 37 percent (40.8 percent once the Medicare surtax is tacked on).
So C Corp seems to be the way to go right? Not so fast…
A New Twist – A Deduction for “Qualified Business Income”
Congress also created a new deduction for qualified business income from eligible flow-through entities. The new deduction allows for a deduction of up to 20 percent of qualified income. Owners of a business that qualifies for the full deduction amount could face a top federal effective tax rate of 33.4 percent.
So who qualifies for this special new deduction?
Unfortunately, the new law has temporarily left us with more questions than answers. What we know at this point (Fall 2018) is that income from businesses in the fields of health, law, accounting, investment management and consulting is not subject to the deduction if it exceeds $157,500 in a year ($315,000 in the case of a joint return).
In addition, a business is ineligible for the deduction if its “principal asset” is the “reputation or skill” of one or more employees and/or owners. The Freed Maxick Tax Team is still awaiting further guidance as to what the lawmakers meant to exclude with this language.
But Wait, There’s More…Other TCJA Provisions that Should be Considered in a Business Entity Selection Evaluation
The rate changes and flow-through deduction are the most obvious changes to the entity choice calculation, but the tax code is full of other provisions that should be considered in a re-evaluation, including:
- Taxes on international income will play a much bigger part in the choice of entity under the TCJA. Businesses with any type of international operations will need to consider the new global low-tax intangible income (“GILTI”) and foreign-derived intangible income (“FDII”) provisions.
- GILTI applies to income generated by a company’s controlled foreign C corporation and creates an additional U.S. tax liability on the overseas profits.
- FDII provides a tax advantage for income generated by a U.S. taxpayer from:
- The sale of tangible property for foreign use, or
- The performance of services for foreign customers where the benefit is derived by a foreign customer in a foreign location.
For a more extensive discussion of these two provisions read our related articles about GILTI here.
- Qualified small business stock (QSBS) treatment may allow individuals to exclude gain on sale of their stock if it meets certain criteria including but not limited to:
a.) acquired as part of an original issue by a domestic C corporation
b.) had no more than $50 million in assets as of the date of stock issuance
c.) engaged in a “qualified trade or business”, examples of certain types of business specifically excluded from the definition of “qualified trade or business” include health, law, engineering, architecture, accounting, consulting, athletics, banking, insurance, investing, restaurants, and hotel/hospitality
State Tax Considerations Regarding Business Entity Selection Choices
Your business cannot afford to forget that state and local taxes play a huge part in determining the tax advantages of a particular entity choice. Depending on where your business operates, the amount and type of activities it performs in those locations, and the applicable tax rates, the impact of non-federal taxes can always sway an entity choice to one side of the fence or the other.
For more insight, observations and guidance on the new Tax Cuts and Jobs Act, visit our Tax Reform webpage.
As with many tax discussions the devil is in the details. Given the amount of guidance still to come from the IRS, we don’t even have all of those details yet. Be sure to subscribe to Freed Maxick’s e-mail service for updates as new information becomes available.
Meanwhile, if the issues discussed in this article have you wondering about choosing a business entity and if you need to reevaluate your selection, it’s never too early to start the discussion. Please contact Freed Maxick via our contact form, request a Entity Selection consultation, or call us at 716.847.2651 to discuss your situation.
The IRS has released a new notice aimed at clarifying the effect of the TCJA on the deductibility of business meals and entertainment. According to the Service, "Taxpayers may continue to deduct 50 percent of the cost of business meals if the taxpayer (or an employee of the taxpayer) is present and the food or beverages are not considered lavish or extravagant. The meals may be provided to a current or potential business customer, client, consultant or similar business contact."
The notice lists 5 tests for deductibility. Taxpayers may deduct 50 percent of an otherwise allowable business meal expense if:
- The expense is an ordinary and necessary expense under section 162(a) paid or incurred during the taxable year in carrying on a trade or business;
- The expense is not lavish or extravagant under the circumstances;
- The taxpayer, or an employee of the taxpayer, is present at the furnishing of the food or beverages;
- The food and beverages are provided to a current or potential business customer, client, consultant, or similar business contact; and
- In the case of food and beverages provided during or at an entertainment activity, the food and beverages are purchased separately from the entertainment, or the cost of the food and beverages is stated separately from the cost of the entertainment on one or more bills, invoices, or receipts. The entertainment disallowance rule may not be circumvented through inflating the amount charged for food and beverages.
The notice also announces that Treasury and IRS plan to publish proposed regulations on the issue. Comments are requested by December 2 of this year regarding the guidance in the notice, so it seems likely that the regulations would be published some time after that.
To learn more about how this notice affects the deductibility of your business meals and entertainment, or address any questions you may have, please contact us here or call the Freed Maxick Tax Team at 716.847.2651 to discuss your situation.View full article
Microbreweries often experiment with flavors and processes in ways that may qualify for a significant federal tax credit.
When craft brewing is done right, it often seems more like art than science. So it should come as no surprise that many craft-brewers overlook a tax-saving opportunity that is more closely associated with science-based industries like pharmaceuticals and tech companies.
The Federal Research & Development (R&D) tax credit provides a federal tax credit based on certain expenditures business spend on “qualifying research activities” (QRAs). Additional incentives are available for certain startups and smaller breweries, such as credit against certain payroll taxes and not being limited by the alternative minimum tax.
Qualifying Research Activities for Breweries and Microbreweries
That phrase “Qualified Research Activities” is the heart of the argument for applying the credit to certain microbrewery expenditures. Costs related to an activity that meets the four-part test to qualify for the R&D credit, regardless of the industry in which the business operates.
Examples of qualified activities for Breweries and Microbreweries include, but are not limited to:
- Developing new or improved hopping techniques, including testing new varieties or combinations of varieties. In fact, according to gardeningknow.how.com, there are about 80 different hops types commercially available. It’s not unreasonable to think that many others are in development.
- Develop new or improved malting, lautering, fermenting, or conditioning processes.
- Developing new or improved bottling processes to improve shelf longevity, lower cost, or other functional improvements,
- Improvements to your brewing process to reduce waste, improve water recycling throughout the process, improve filtration, reduce cycle time, or other functional aspects,
- Development related to new product formulations, including use of different ingredients or preservatives.
Deductibility is in the Details
The potential benefits of the R&D credit are significant, so the government requires thorough documentation. If you’re planning to claim the credit, you’ll want to set up your accounting system to track QRAs in separate accounts. Time allocations for employees engaged in R&D are an important part of your records. Actual timesheets and payroll records are the strongest support. These can be supplemented with post-completion analyses of resources used, design drawings for proposed developments/improvements, meeting notes, and testing documentation.
Extra Benefits for Start-Ups and Small Businesses
The IRS rules don’t go into specifics about what constitutes sufficient documentation for any particular claim, but they do express a strong preference for contemporaneous documentation. If you’re planning to claim the R&D tax credit for your brewery or microbrewery, it’s important to consult with a knowledgeable professional at the outset (or as soon as possible after starting!) to build the system that will document your costs accurately as you go.
The PATH Act of 2015 made the R&D credit permanent and even more valuable to microbrewery start-ups and small businesses. If you are a brewer with less than $5 million in current-year gross receipts and no gross receipts for any tax year that precedes the fourth preceding tax year, you can elect to claim up to $250,000 of the credit against your employer portion of Social Security tax. Partnerships, sole proprietorships and privately held corporations whose average annual gross receipts for the last 3 years that do not exceed $50 million, can also claim the credit against an alternative minimum tax liability.
State Incentives for Brewers in New York
The Empire State also offers several incentives for brewers operating within its borders. Credits for investment in buildings and equipment apply to brewers, as do income and property tax credits for manufacturers. New York also provides an alcoholic beverage production credit and, for locally sourced beers, some reduced permit requirements. In addition, breweries can qualify for the state’s START-UP NY business incentive program, depending on their location.
Brewing Up Your Credit
Securing both Federal and New York State credits and incentives requires detail analysis and documentation. In some cases this will require presentation to tax authorities in an audit to defend your position.
That’s why you’ll want to work with a team of experts with impeccable credentials in helping businesses of all types and sizes use the R&D Credit -and other tax minimization strategies – to lower their tax burden.
For more information about how your microbrewery could benefit from the R&D tax credit, please contact Freed Maxick at 716.847.2651.
Six clarifications regarding the 20% deduction for passthrough businesses
The new tax law enacted in December of 2017 included many noteworthy provisions. In some cases, the law generated more questions than answers about how taxes would look in 2018 and beyond. One provision that couldn’t be fully understood without significant guidance from the IRS was the 20 percent deduction for passthrough businesses, or “Section 199A.”
Congress created Section 199A so that owners of these entities could deduct a piece of their business income “off the top” before calculating their personal tax. That sounds simple enough in theory, but in order to give businesses a break without creating a wealth of opportunities for tax avoidance, certain limitations and special circumstances needed to be addressed.
Clarifying How Section 199A Will Work in Practice
The IRS recently released several pieces of Section 199A guidance designed to clarify how the law would apply in practice.
- Operational rules: This section takes Congress’ legislative language and begins to translate it into instructions on a tax form. It covers the nuts and bolts of how the provision works when there are no special circumstances to address. For instance, many taxpayers will fall within the income limits ($315,000 for joint returns or $157,500 for other filers) that allow them to take the full 20 percent deduction from their passthrough income. Those folks may have a relatively uncomplicated calculation to determine their deduction.
- Limits based on wages paid: In some situations, the deduction may be limited based on a percentage of the wages a passthrough business pays to employees. The guidance includes 3 possible methods for calculating this limitation.
- Limits calculated from basis in acquired property: The regs offer guidance on limitations based on an owner’s basis in different types of property. Given the variety of property types and special circumstances based on the timing of property transactions during the year, the calculation of the deduction limitation gets very complicated if this section applies.
- What constitutes "business income?" If the only passthrough businesses these rules had to cover were grocery stores owned by Mom and Pop as partners, it would be pretty easy to determine what M & P’s business income was. However, passthroughs can be created to invest in other passthroughs and they can have a wide variety of income types that may or may not look like income from a business. In addition, some types of income might be business income for some businesses but not for others. For instance, income from real estate holdings could be business income to a real estate partnership, but not to a grocery store that owns its building and rents space to tenants.
- Aggregating business income for owners of multiple passthroughs: Many taxpayers own interests in multiple passthrough entities. The rules allow taxpayers to aggregate multiple entities for purposes of applying the wage and property limitations.
- Provisions aimed at keeping businesses from turning employees into small businesses: Congress intended for Section 199A to deliver tax relief to passthrough entities that would be comparable to the tax rate relief it enacted for corporations. It was not their intent to encourage every employer and employee to recharacterize their relationship as contractor and contractee in order to game the system. The guidance includes rules aimed at limiting the ability of businesses to make such a change.
The recent Section 199A guidance covers a lot of ground when it comes to answering questions raised by the 2017 law. But much of what the IRS has released is “proposed” guidance, meaning that it’s not the last word on the topic. and the Service expects to hear from tax professionals and taxpayers about questions the guidance didn’t answer as well as new questions that have arisen as a result of the guidance.
Connect with Us to Discuss Your Section 199A Opportunity
If your tax return includes income from a passthrough business, you need to stay in touch with your tax adviser in the months ahead to understand just how the new law will affect you in 2018 and beyond.
If you want to discuss your situation and eligibility for the 20% deduction, please email me at Mike.VanRemmen@FreedMaxick.com or call me at 716.847.2651. As always, if you need additional information about any aspects of the Tax Cut and Jobs Act, please contact the Freed Maxick Tax Team.View full article