On April 9, 2013, Maryland’s Governor, Martin O’Malley, approved HB 386 extending and expanding Maryland’s research and development (R&D) tax credit.

Maryland’s current R&D tax credit law provides a credit against regular Maryland tax for companies incurring qualified research expenses (QREs) within the state. Maryland currently caps its R&D credits at $6 million per calendar year. It offers two types of credits:

• A basic credit equal to 3% of Maryland QREs paid during the tax year, up to the Maryland base amount¹; and
• A growth credit equal to 10% of the Maryland QREs paid during the year which exceed the Maryland base amount.

 
The basic credit is determined first, and then the growth credit is calculated. The combination of the two amounts is the total potential credit. To qualify for the R&D tax credits, a business must submit an application no later than September 15th of the year following the tax year the QREs were incurred. Tax year 2012 applications must be postmarked by Monday, September 16, 2013. The application is reviewed and certified after December 15th of the year following the tax year the QREs were incurred. Once certified, the business must attach the certification to its amended Maryland return claiming the R&D tax credit.

In the likely event that State R&D tax credit claims exceed the maximum allowed, the credits are allocated² among all claimants who have filed their application by the September 15th deadline. R&D expenses, typically categorized as a business expense, are deducted from State tax liability. Maryland requires claimants to add back to Maryland adjusted gross income the amount of any credits claimed. The R&D tax credit was set to expire on June 30, 2020.

New Law: With the passage and approval of HB 386, Maryland’s annual R&D tax credit cap is increased to $8 million of credits. Although, the credit calculation and allocation method remains unchanged, the credit may be refundable for eligible small businesses, provided that:

• The business is a for-profit corporation, LLC, partnership, or sole proprietorship; and
• At the beginning or end of the taxable year in which eligible QREs are incurred, the business has a net book value of assets of less than $5 million.

 
The new law becomes effective June 1, 2013, and applies to all R&D tax credits certified after December 15, 2012. The annual application process remains the same and the credit now sunsets on June 30, 2021.

1. The base amount is equal to the average Maryland QREs incurred by the business during the four years preceding the credit year.
2. The allocation is calculated by multiplying each claimant’s credit applied for by the ratio of the maximum allowable credit for all claimants to the total amount of credits applied for by all claimants.

Union Carbide Corporation R&D Tax Credit Case Now Final: The Supreme Court denied certiorari review on March 18, 2013

The widely followed R&D Tax Credit case involving Union Carbide Corporation (UCC) and the cost of supplies used during production has finally come to an end. On March 18, 2013, the Supreme Court denied review of the Second Circuit Court of Appeals decision, which had affirmed the Tax Court.

UCC was developing and improving multiple manufacturing processes. During the evaluation of the new and improved processes, the taxpayer manufactured product and claimed that the raw materials used (to produce goods) in the testing of the processes were supply costs that qualified for the research credit.

UCC’s position was that Code Sec. 41(b)(2)(A)(ii) entitled it to a “credit for the cost of all supplies used in the production of the product even though those supplies would have been used regardless of any research performed.” Union Carbide Corp. & Subsidiaries v. Comm’r, 110 AFTR 2d 2012-5837, 5838 (9/7/2012).

However, the Tax Court disagreed and held that only those additional costs related to the conduct of evaluating the new\improved process were qualified. The Tax Court also held that the cost of the raw material, which would have been purchased and used in normal production, were “[a]t best, … indirect research costs excluded from the definition of qualified research expenses under Reg. §1.41-2(b)(2).” Union Carbide Corp. & Subsidiaries V. Comm’r, TC Memo 2009-50, 276 (3/10/2009). The Second Circuit agreed with the Tax Court on both issues.

A key take-away from this case is how you examine supply costs when a taxpayer seeks a research credit related to its production process. One must examine separately those costs related to the production process versus those related to the product produced. Each is considered a separate business component. Section §41(d)(2)(C) provides, “Any plant process, machinery, or technique for commercial production of a business component shall be treated as a separate business component (and not as a part of the business component produced).”

Notwithstanding the recent Supreme Court denial to hear the case, the Tax Court opinion, which is 298 pages, has been viewed favorably by taxpayers in that it rejected several common IRS positions asserted during audits. The Tax Court opinion issued by Judge Goeke addressed issues such as, allowing cost accounting based records along with business records regularly produced to substantiate costs, acceptance of the “Cohan Rule” to estimate wage and supply expenses, and the use of testimonial evidence supported by documentary evidence to support prior year qualified expenses. The Tax Court opinion also provided some clarification and guidance on the consistency rules, the discovery test, and the process of experimentation.

» Recent R&D commentary

» This article is published in Accounting Today with permission

IRS to Create Repair vs. Capitalization Guidelines Specific to Retail Industry

Recently, the IRS and the Treasury Department announced that they have accepted a request from the National Retail Federation and Retail Industry Leaders Association for guidance under the IRS’ Industry Issue Resolution (IIR) program regarding the new Repair vs. Capitalization Regulations. The purpose of the IIR Program is to resolve frequently disputed business tax issues in a particular industry with the goal of reducing time and expenses that would otherwise have been expended on tax examinations.

The specific issues of note the retail industry requested clarification on are: Application of unit of property

• Repair and remodeling expenses
• Rules for general maintenance and repair expenses

» Read the IRS notice

KBKG will follow the progress of this IIR and keep you up to date with developments. The Repair vs. Capitalization Regulations are expected to be finalized in 2013 with an effective date of January 1, 2014. These regulations are applicable to businesses in all industries that acquire, produce, replace or improve tangible property. For more information on the Repair vs. Capitalization Regulations, please see prior commentary issued by KBKG here.

To find out if the new Repair vs. Capitalization regulations will benefit you, visit kbkg.com/assetretirement

Summary: In the recently released Chief Counsel Memo #20125201F, the IRS makes it clear that even if you engage a third party to perform a cost segregation analysis, taxpayers cannot avoid penalties for aggressive positions taken in the cost segregation report.  This particular instance involves the issue of improperly classifying a parking deck as a 15-year land improvement instead of a 39-year building.  The taxpayer attended a presentation that addressed open-air parking structures in which the presentation slides indicated certain regulations “support the argument that parking structures belong in the land improvement category.”  The taxpayer hired the firm to conduct a cost segregation study and received a memo which concludes that a parking structure generally does not meet the definition of a building.  Under audit, the taxpayer argued that it had reasonable cause to take this position because the extensive research they conducted on the issue was “supported by the issuance of a study provided by a firm with technical expertise in the subject matter.”  However, the study contained no analysis of the facts regarding the parking structure at issue.  Chief Counsel also states the cost segregation study in question “lacks the factual information upon which its conclusions are based.”  Based on these deficiencies, it was not reasonable for the taxpayer to have relied on the cost segregation study as a defense to an accuracy-related penalty.  Under section 6662, the negligence penalty is 20 percent of the underpayment in tax.  This case emphasizes the importance of using a trustworthy cost segregation firm that has significant experience dealing with IRS audits. 

Facts: This taxpayer was a partner in an entity that was previously examined for the issue of open air parking structures in which the IRS disallowed a 15 year recovery period.  Under appeals, the IRS and the taxpayer reached a settlement on the issue.  Under the more recent examination, the taxpayer placed a new parking structure into service and referred to it as “Parking Garage.”  They hired a 3rd party firm to conduct a cost segregation study.  The taxpayer received a memo which concludes that a parking structure generally does not meet the definition of a building.  This suggestion is notwithstanding the discussion in the memo of the “function test” in section 1.48-1(e), which states that a structure is a “building if its purpose is, for example, to provide parking.”  The memo acknowledges that in most cases, a parking structure will meet the “function test since parking is one of the enumerated purposes in the regulation,” but then incorrectly states that the appearance test is the “decisive factor” because a parking structure does not have walls or a roof, is open to the elements, and is not designed to provide shelter.  The memo contains no discussion of the numerous cases that disregarded the appearance test over the function test, nor of the cases that have disregarded the argument that “walls” are necessary under the appearance test.  Further, the applicable authorities are clear that a building is not required to have walls to enclose its space.

Analysis and Comments: The taxpayer provides a number of additional arguments to defend their position and avoid penalties.  However, I believe that the IRS is correct in their conclusion.  The function test in section 1.48-1(e) provides that a “building” generally means a structure “the purpose of which is, for example, to provide shelter or housing, or to provide working, office, parking, display, or sales space. The term includes, for example, structures such as apartment houses, factory and office buildings, warehouses, barns, garages, railway or bus stations, and stores.”  The purpose of the parking structure in this case is to provide parking so it clearly meets the function test. 

Further, in 2009, the IRS released a coordinated issue paper (LMSB4-0709-029) regarding the applicable recovery period under section 168(a) for open-air parking structures.  The paper concludes that, based on Rev. Proc. 87-56 (Asset Class 00.3) and section 1.48-1(e), an open-air parking structure is a building and therefore has a 39-year depreciable life.  Although this coordinate issue paper was released after the taxpayer filed its tax return, the cases and regulations upon which the coordinated issue paper is based existed well before taxpayer filed its tax return and is authority for purposes of evaluating reasonable basis.

Closing: This case emphasizes the risks of not using an established cost segregation firm with significant experience.  Many careless cost segregation providers have taken the exact same position in their reports without advising their clients of the risk associated with it.  The negligence penalty under Section 6662 explicitly excludes opinions rendered by tax professionals, so selecting the right cost segregation provider is critical.  The only way to ensure a cost segregation provider meets the highest industry standards is asking them if they are a “Certified cost segregation Professional” (CCSP) with the American Society of cost segregation Professionals.  Any other credential is substandard.  You should also request multiple references of clients that have gone through audit where IRS engineers actually reviewed the cost segregation study.      

Action Step: It’s not too late for KBKG to perform a Cost Segregation study for your or your client.
Call us or fill out the Cost Segregation qualification form and answers a few questions to see if you can benefit from a study.

  Author:
  Gian Pazzia, CCSP
  Shareholder
  ASCSP Certified Member #C0029-07
  » Biography

Pursuant to the rules of professional conduct set forth in Circular 230, as promulgated by the United States Department of the Treasury, nothing contained in this communication was intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose. No one, without our express prior written permission, may use or refer to any tax advice in this communication in promoting, marketing, or recommending a partnership or other entity, investment plan or arrangement to any other party.

» This article is published in Accounting Today with permission

IRS Notice 2013-14 authorizes employees eligible for the Work Opportunity Tax Credit under non-VOW Act criteria to be certified by a state workforce agency through April 29, 2013 if they were hired between January 1, 2012 and March 31, 2013. The entire text of the Notice can be found here: http://www.irs.gov/pub/irs-drop/n-13-14.pdf.

As you may be aware, the California Enterprise Zone program is currently undergoing an administrative rulemaking process which will severely reduce or eliminate the tax credit for many businesses. New regulations are anticipated to go into effect in June. Businesses located in Enterprise Zones should review their tax credits to ensure all available credits under the current regulations have been maximized. KBKG can help, but the time to conduct such a review is now. Businesses that delay this process will have limited options to file under the old regulations due to the time constraints involved with certifying these tax credits with government agencies.

Please contact our knowledgeable staff as soon as possible if you have questions about Enterprise Zones or would like KBKG to assist you in conducting a final review under the current regulations. KBKG serves the CPA community with focused expertise in our areas of service. If you have any questions about these rules, please know that we are always available to answer your questions.

» See if you are located in an Enterprise Zone

For tax years beginning on or after January 1, 2012, the State of Florida allows a qualified “business enterprise” to claim a state R&D credit of 10% for qualified research expenses (“QREs”) incurred in Florida (2012 Florida Statute §220.196).

Is there an application process?
Yes. An application process must be completed in order to be considered for the credit. Applications may be filed with the department on or after March 20th for the QREs incurred in the preceding calendar year.

The total annual R&D tax credits available for all taxpayers is limited to $9 million and is granted on a first come first serve basis (determined by the date the “completed applications are received”).

So who can qualify for the credit?
First, the “business enterprise”, must be a corporation as defined under section 220.03. Section 220.03(e) specifically provides partnerships of any type, including LLC’s taxed as a partnership for federal purposes, are not included. Second, the business enterprise must be in a “target industry business” as defined in section 288.106. A target industry business is generally one which has potential for future growth, is not subject to periodic layoffs or sensitive to seasonality, pays relatively high wages, the industry contributes to the state’s or an area’s economic base, and is expected to have a strong positive economic impact.

Specifically excluded from the “target industry business” definition are any retail industry activities; any electrical utility company; any phosphate or other solid mineral severance, mining or processing operations; oil & gas exploration or production; or businesses in the hotel and restaurant industry.

How much is the credit worth? How is it calculated?
The credit is equal to 10% of the excess current year QREs over the base amount (the average of the immediately prior 4 years QREs).

If a business enterprise, or its predecessor, has not been in existence for at least the immediately prior 4 taxable years, then the maximum credit is reduced by 25% per year for which the company did not exist.

Is the credit limited in how much can be used each year?
Yes. The credit amount which may be used in any one year is limited and may not exceed 50% of the business enterprise’s remaining net income tax liability after all other credits have been applied as provided under §220.02(8). Any unused credit is only allowed to be carried forward and claimed for up to 5 years.

Call today or fill out the qualification form for a free R&D analysis to see if your company could benefit from the Federal and new 2012 Florida R&D tax credit opportunity.

Congress passed a two-year extension for the R&D Tax Credit as part of the Fiscal Cliff Relief bill. The “American Taxpayer Relief Act of 2012″ (the Act), which the President signed into law on Jan 2, 2013, extends the credit retroactively and is now set to expire at the end of 2013. This is the 15th credit extension since the original enactment in 1981. The latest credit provisions expired for those R&D expenditures which were paid or incurred after December 31, 2011. For fiscal year-end taxpayers, the retroactive extension will provide an opportunity to amend their 2011 return in order to claim those qualified expenditures which occurred in 2012.

The Act also addresses the adjustments required for qualified research expenses (QREs), gross receipts & the related base period when there is an acquisition or disposition of a trade or business, or a major portion of a trade or business. The adjustments are based on the number of days from the date of acquisition through the end of the acquiring person’s tax year.

Finally, the Act also simplifies the allocation of the controlled group credit among its members. The controlled group credit is allocated based on each member’s proportionate share of the group’s total QREs. The two year retroactive extension is great news for businesses that currently qualify for the R&D tax credit. Hopefully, as Congress continues to work through the fiscal issues, they will find a way to make the R&D credit permanent.

If you are developing, improving or refining products, processes, formulas, and computer software, you may qualify for the R&D Tax credit. » Find out if you qualify

Tax Alert: Energy Efficiency Tax Credits for Multifamily Developers Extended as Part of Fiscal Cliff Agreement

In an effort to avert the “Fiscal Cliff”, Congress passed the American Taxpayer Relief Act of 2012 on New Year’s Day, and President Obama has vowed to sign this into law soon. This bill extends many key business tax extenders including the Section 45L tax credit which rewards multifamily developers with tax credits of $2,000 per energy efficient apartment unit. The Section 45L tax credit had expired at the end of 2011 but this bill extends the tax credit for another two years, through the end of 2013.

To illustrate how this tax cut works, KBKG recently analyzed a newly constructed 98-unit apartment complex and certified and secured $196,000 (98 x $2,000 per unit) in Section 45L tax credits.

In addition to extending these tax credits, Congress has modified the energy efficiency criteria for units that are leased in 2012 & 2013. With state and local energy codes having been made more stringent in recent years, great potential exists for developments to already meet the criteria for these tax credits. KBKG has successfully secured millions in Section 45L tax credits for developers throughout the country.

Action Step: If you are currently developing or have developed a multifamily project in the past 5 years, you may be a good candidate to secure these tax credits. Call us today or visit KBKG.com/45L/qualify and answer a few questions to see if you are eligible. Please note that if you have leased any units in 2009, your deadline for retroactively securing missed 2009 tax credits is fast approaching in the next few months.

On Friday, December 14, the IRS published the amended temporary Repair vs. Capitalization regulations to incorporate the changes announced in the recent Notice 2012-73. The changes include a two year delay of the effective date of the regulations to January 1, 2014.

While Notice 2012-73 indicated that taxpayers had the option to apply the temporary or final regulations for any tax year beginning after 1/1/2012, it was unclear whether taxpayers could pick and choose to apply only favorable portions of the regulations for those years. These formal amendments clarify this question and make clear that you can. As such, taxpayers and CPAs, should not overlook the possible tax benefits of applying favorable portions of the regulations immediately.

With the delay of the effective date to 1/1/2014, some taxpayers are hesitant to file the necessary Change of Accounting Method forms for 2012 because of concern the rules will change. However, CPAs should advise taxpayers that even if the regulations do change and some deductions must be reversed in 2014, such deductions would be given back evenly over four years starting in 2014 (See Rev. Proc. 2011-14). In most cases this will not result in a significant difference in tax savings. However, depending on the situation, some taxpayers may benefit from applying the rules immediately.

KBKG can help estimate the additional deductions that can be generated by applying these rules immediately. See if you qualify: KBKG.com/assetretirement

This article was published in Accounting Today on Dec 17, 2012
» View the article