Advanced Tax Strategies...Advanced tax strategies covered in this eGuide include: To learn more about these strategic tax planning strategies, and how they might benefit your business

AdvancedTax Strategies

www.wndecpa.com

A Guide to Strategic Tax Credit and Planning Opportunities

INTRODUCTIONManaging tax liabilities is a key objective of all CFOs and business owners. Any uncertainty related to whether or not all applicable tax credit and planning options are being utilized can be an ongoing concern. At WNDE, we believe that an important part of our role as your CPAs and tax advisors, is to help make sure that you and your business are aware of all potential tax credit and tax planning opportunities that might be appropriate for your individual situation.

As a service to our clients and the business community, WNDE has written a series of articles focused on advanced tax strategies that businesses can consider in efforts to minimize tax liabilities. As part of our tax planning services, WNDE encourages the utilization of available strategic tax credit and planning opportunities. This eGuide can serve as a comprehensive resource to help business owners be proactive with their strategic tax planning initiatives.

Advanced tax strategies covered in this eGuide include:

To learn more about these strategic tax planning strategies, and how they might benefit your business and improve your tax position, please reach out to WNDE today. You may reach us at (714) 978-1300 or [email protected].

• Research & Development Tax Credits

• Cost Segregation

• Hiring Credits

• Insurance Captives

• Interest Charge Domestic International Sales Corporations (IC-DISC)

• Section 199A Pass-Through Deductions

• Bonus Depreciation

WNDE | Advanced Tax Strategies

RESEARCH & DEVELOPMENT TAX CREDITSQuestions about the Research & Development Tax Credit? We’ve got you covered.

WHAT IS THE RESEARCH & DEVELOPMENT TAX CREDIT?

Enacted in 1981, the Research & Development (R&D) Tax Credit is a federal tax incentive that functions to encourage companies to make R&D investments within the United States. It offers a broad definition of “research & development” that allows companies engaged in a wide variety of activities to qualify for the tax credit. Many states also offer additional R&D incentives.

HOW DOES THE R&D TAX CREDIT WORK?

The federal R&D credit offers a dollar-for-dollar reduction in income tax liability on qualifying expenses in a given year. The credit can be carried back one year and forward 20 years. The R&D Tax Credit is annual, meaning companies can take advantage of it every year. The statute of limitations for the credit is generally three years; if a company is in a Net Operating Loss, however, it can look back more than three years.

WHO CAN THE R&D TAX CREDIT HELP?

Generally speaking, companies that invest in qualified R&D activity can benefit from the R&D Tax Credit if they have paid, currently pay, or expect to pay federal income tax (and/or a similar state tax, if performing qualifying activity in a state with R&D incentives). Broadly speaking, companies that fit one of the following descriptions qualify to take the R&D Tax Credit:

• Companies that develop brand new products, processes, software, or formula

• Companies that develop material improvements to existing products, processes, software, or formulae

• Companies that hire employees for their technical backgrounds (e.g., software developers, engineers, etc.)

As a result of the Credit’s broad definition of “research & development,” a wide variety of companies and industries can benefit from the tax incentive. A non-exhaustive list of qualifying industries includes:

• Aerospace & Defense

• Agriculture

• Automotive

• Chemicals

• Hi-Tech

• Engineering

• Food Science

• Manufacturing

• Hardware Development

• Pharmaceuticals

• Semiconductors

• Software Development

• Telecommunications

WHAT ACTIVITIES QUALIFY FOR THE R&D TAX CREDIT?

The R&D Tax Credit uses a four-part test to evaluate the qualification of activities. An activity must meet each element of the test, and not be on the list of exclusions. This test asks whether an activity does one of the following:

1. Eliminates a technical uncertainty in regard to a product’s capability, method or design

2. Is technical in nature (i.e., relies upon physical science, biological science, computer science, and/or engineering)

3. Uses the process of experimentation, including evaluating alternatives

4. Involves the development of new or improved products, processes, software, or formulae


Since the goal of the R&D Tax Credit is to incentivize increased research and development within the United States, exclusions exist for activities that:

• Are conducted outside of the U.S.

• Rely on the social sciences, arts, or humanities (rather than the sciences listed in #2, above)

• Exist only to collect routine data or perform ordinary testing for quality control of existing components

• Can be defined as market research (e.g., consumer preference testing)

• Are funded by an unrelated third party, resulting in the taxpayer not retaining the rights to the results of the activity, and/or exist only to develop or improve software intended primarily for use by the taxpayer (there are some exceptions to this exclusion)

A non-exhaustive list of activities that qualify for the federal R&D Tax Credit includes the following:

• The development or testing of new products or materials

• The development of new or enhanced formulations

• The testing of new concepts

• The improvement of existing products

• Experimentation by trial and error

• The design of tools, jigs, and molds

• The design and analysis of prototypes or models

• The development or improvement of production or manufacturing processes

• The development, implementation, or upgrading of systems or software

• Payments to outside consultants or contractors to perform any of the above-mentioned activities.

WHAT EXPENSES QUALIFY FOR THE R&D TAX CREDIT?

According to the regulations of the federal R&D Tax Credit, qualifying costs include:

1. Any supplies used and consumed during the development process (must be non-depreciable property)

2. Wages paid for employees involved in the qualifying activities (either performing, supporting, or supervising the qualifying activities)

3. 65%-100% of the amounts paid to non-employees (e.g., contractors) involved in the qualifying activities

4. The rental or lease costs of computers used in the qualifying activities.


For taxpayers who own investment or owner-occupied commercial real estate, and are seeking to lower their income tax bill, cost segregation can be a great option. Read on to discover more about this key tax-savings strategy.

WHAT IS COST SEGREGATION?

The term “cost segregation” refers to a tax-planning practice used to defer federal and state income taxes. Via a detailed cost segregation study, a business identifies all property-related component values and allocates them into their most tax-efficient, useful, life-depreciation categories.

HOW DOES COST SEGREGATION WORK?

Consider the scenario where a business purchases a new building. Using a standard, straight-line schedule, a building structure generally depreciates over either 27 ½ or 39 years. However, there are many items included with the building that depreciate more quickly than the structure, such as tenant improvements, electrical and lighting, carpeting, parking lots, equipment, and fixtures, to name a few. Cost segregation separates out items that depreciate at a faster rate, allowing them to be expensed sooner.

In order to do this, a business must commission a cost segregation study. These studies require the expertise of a qualified engineer and/or architect, who inspect the property, estimate the value of each component, and then assign the proper tax classifications. Cost segregation studies can be performed at any point after a building is purchased.

WHAT ARE THE BENEFITS OF COST SEGREGATION?

By allowing business owners to claim more deductions sooner, cost segregation results in more cash available up front, which can be crucial to operations. On top of that, cost segregation studies provide a secondary benefit in the form of valuable information about business assets. For example, if a business were to replace its windows, it could consult a previous cost segregation report in order to obtain the details needed to write off the cost of the purchase.

WHO QUALIFIES FOR COST SEGREGATION?

Anyone can have a cost segregation done, but in order to make it worthwhile, it only makes sense to consider doing it if you have spent $500,000 or more to construct, purchase, expand, or remodel.

WNDE Cost Segregation ServicesAlthough we do not conduct the actual study, our highly-qualified team of tax professionals have worked with many clients to implement cost segregation strategies, resulting in hundreds of millions of dollars in tax benefits. Ready to get started? Contact your WNDE tax professional today for a free estimate of your tax benefits.

COST SEGREGATION


HIRING CREDITS

WHAT ARE HIRING/EMPLOYMENT CREDITS?

Hiring and employment credits are tax credits that exist in order to incentivize the hiring of employees of a specific demographic and/or in a particular location to encourage economic growth through increased employment, new technology, and improved civic infrastructure.

Some of the most popular hiring and employment credits include:

The Work Opportunity Tax Credit – Provides a federal credit of up to $9,600 (per eligible employee) for employers who hire individuals who qualify as members of target groups. There is no cap on the number of eligible people for which a business may claim this credit. The target groups include people who typically face high barriers to entry in the workforce, including:

• Veterans

• Temporary Assistance for Needy Family (TANF) Recipients

• Supplemental Nutrition Assistance Program (SNAP) Recipients

• Designated Community Residents, including Residents of Empowerment Zones or Rural Renewal Counties

• Vocational Rehabilitation Referrals

• Ex-Felons

• Supplemental Security Income (SSI) Recipients

• Summer Youth Employees

• Long-Term Unemployed

The Payroll Tax Credit – An extension of the tax credit for research and development, this credit allows “qualified small businesses” that are performing “qualified research” to offset up to $250,000 of the employer portion of FICA payroll tax.

Federal Empowerment Zone Tax Credits – A credits for hiring and retaining employees who live and work within designated distressed communities. Business that qualify can earn up to $3,000 per eligible employee.

Assorted State Hiring Tax Credits – Most states offer a variety of credits with the goal of incentivizing job creation and bolstering the local economy. Visit your state’s Department of Revenue website or consult your tax advisor for more information.

WHO CAN USE HIRING CREDITS?

Each credit comes with its own specific criteria. Some require that employees belong to a particular demographic, while others have requirements pertaining to where an employee lives or works. Private companies, C Corporations, S Corporations, LLC’s, and 501(c)’s all qualify for a variety of federal and/or state hiring and employee tax credits.

WHAT ARE THE BENEFITS OF HIRING CREDITS?

When a business files their taxes, the total amount of any tax credits for which they file is subtracted from their tax liability, thereby reducing their total tax burden. Money saved can be used for a variety of purposes, such as to offset costs for recruiting, onboarding, and training new employees, or for investment back into the business.

These tax credits are important for their contributions to the local and national economy. They encourage business owners and managers to hire workers who often face significant barriers to employment. They contribute to greater diversity in the workplace. Lastly, they help raise the employment rate, which means more workers can move towards self-sufficiency and become contributing taxpayers themselves.

WNDE Hiring Credits ServicesWNDE’s team of tax professionals are thoroughly versed on the most up-to-date versions of both federal and state tax credits available in California. Reach out to one of our advisors today for more information or if you have any questions.


INSURANCE CAPTIVES

WHAT IS A CAPTIVE INSURANCE COMPANY?

A captive insurance company is generally a corporation that is formed in a legal jurisdiction (U.S. states or foreign countries) and subject to various industry regulations (federal, state, international governance) and income tax authorities for both the insurance company and the insured.

Insurance captives are a type of risk-financing tool. The term “captive” refers to the fact that the insurance company is owned and controlled by its insureds, in the form of a governing Board of Directors. The captive functions much the same as a regular insurance company, evaluating risks, writing policies, managing claims, and setting premium levels. The big difference is that it primarily insures the risks of its owners, and not outside parties.

The risks being insured are mostly risks available through traditional commercial insurance companies. However, some risks insurable under a captive arrangement may generally be unavailable through the commercial insurance marketplace or otherwise fill “gaps” in a commercial insurance policy. These risks can include general liability, E & O liability, employee benefits, workers compensation, product liability, cyber risk, environmental, property and more.

HOW DO THEY WORK?

Most captive insurance companies are arranged through captive management companies that assist the insured business in identifying the benefits, costs and burdens of forming the captive insurance company. This captive manager is critical in navigating the captive and the insured through the highly complex and burdensome regulatory

environment, while staying current in a rapidly changing environment (for both industry and taxation policies). The premium pricing and actuarial analysis are critical functions handled by the manager.

The captive entity is a standalone legal entity. Our client captives are generally formed utilizing Internal Revenue Code § 831(b), which can provide substantial income tax benefits for the captive, while still giving rise to deductible insurance premiums for the insured business.

WHAT ARE THE BENEFITS OF INSURANCE CAPTIVES?

Benefits of utilizing captives include potential cost savings, both short and long term, improving cash flow, centralization of investment policies, reducing risk management losses, enhanced control over policy design and claims management and removing commercial insured profit loading.

WHO CAN USE INSURANCE CAPTIVES?

For many small- and medium-sized businesses, captive insurance companies are a viable and productive tool. However, the complexities and costs involved certainly make it a “not for everyone” consideration. Generally, insurance captives are a good choice for companies that excel at risk management, are ready to make a long-term commitment, are financially sound, and have a reasonably predictable insurance risk. If your organization struggles with poor risk management, isn’t strong financially, or is too small to accept the risk of loss, then an insurance captive is probably not right for you.


WHAT ABOUT THE INTERNAL REVENUE SERVICE?

The United States Treasury embraced the use of captives in 1986 by creating Internal Revenue Code § 831 and the § 831(b) election previously mentioned. The genesis of the §831 tax incentives came about in a difficult U.S. economy, whereby small and medium sized businesses found it difficult to find affordable insurance. The § 831(b) election was deemed to be an incentive to bring small and medium sized businesses into the captive arena.

§ 831(b) allows certain small insurance companies (non-life policies) to exclude certain net insurance business income from federal taxation. This exclusion is based on net premium income (gross receipts) of $2.2 million or less as of January 1, 2017 ($1.2 million prior to that). This has the effect of federal taxes applying to only taxable investment income.

The § 831(b) provisions (and other insurance provisions) require that small captives enter shared risk pools (other insured risks are pooled with the insured that creates the captive) and is a critical area under IRS scrutiny. This is relatively easy to navigate with a quality manager (but “other businesses risks are commingled with your business risks.”). Even with the captive endorsement of Congress with the 2016 § 831(b) revenue expansion to $2.2 million, the IRS views all captives with a less than positive lens. In 2016 the IRS issued a notice requiring all parties involved in certain captive insurance programs (micro-captive transactions) to file an annual form with IRS disclosing various details associated with the captive arrangements and the various parties involved in the captive arrangements. The IRS used the term “Transaction of Interest” for this type of captive insurance transaction. In and of itself, this required filing put these transactions in a highly visible and uncomfortable situation.

An IRS examination that identifies the existence of a captive insurance transaction will generally result in a referral to

centralized IRS exam group. It should be expected that an IRS exam that identifies a captive insurance transaction will intensify the examination process and create an initial disallowance of all premiums paid under the captive arrangement. The IRS is generally not interested in auditing the core elements of the captive insurance arrangement nor the criteria established and set forth by the IRS as to “What makes a captive acceptable to the IRS?”. Rather, it is an arbitrary and capricious attack on bona fide and lawful transactions. It is… a bit of vigilante bullying.

The IRS is emboldened by general disdain for its statutory tax benefits and recent cases that have resulted in government victories in light of very problematic taxpayer facts and circumstances. The insurance industry stands to fight a good and righteous fight. The expectation is that substantial taxpayer victories will force the IRS to accept proper and legal captive insurance companies and their arrangements.

WNDE Insurance Captives ServicesIf you think that a captive strategy might be right for your business, and are interested in moving forward with creating an insurance captive, the first step is to commission a captive feasibility study. This study will make a detailed evaluation of your company’s specific circumstances and determine if an insurance captive is the right solution for you, given your needs and position.

WNDE provides a full range of strategic consulting and advisory services for entities seeking help with exploring, establishing and/or maintaining insurance captives. Our experienced tax specialists have the expertise needed to help you make key determinations in this area. To discuss your specific scenario and whether or not an insurance captive is right for your organization, please reach out to WNDE today. You may reach us at (714) 978-1300 or contact us via email at [email protected]


INTEREST CHARGE DOMESTIC INTERNATIONAL SALES CORPORATIONS (IC-DISC)

WHAT IS AN IC-DISC?

In an effort to incentivize exports from the U.S., Congress created the “IC-DISC” designation. IC-DISC stands for Interest Charge Domestic International Sales Corporation. An IC-DISC is a domestic corporation through which producers and distributors of U.S.-made products used abroad can realize significant tax savings.

HOW DOES AN IC-DISC WORK?

In order to derive tax benefits through an IC-DISC strategy, a qualifying producer and/or distributor must form a separate domestic corporation and formally elect for its treatment as an IC-DISC. The IC-DISC must maintain a separate bank account and set of accounting books, and must file an annual U.S. income tax return (though it pays no U.S. income taxes).

WHAT ARE THE BENEFITS OF AN IC-DISC STRATEGY?

The operating company pays a commission to the IC-DISC. The commission can be expensed and, thereby, reduce the operating company’s ordinary taxable income. Additionally, the IC-DISC pays dividends to its shareholders, which are taxed at a favorable rate of 20%. The net of these two items (the tax benefit from the commission deduction and the tax paid on dividend income) results in a permanent tax savings for the operating company and its shareholders.

WHO CAN BENEFIT FROM AN IC-DISC?

As mentioned above, both producers and distributors of U.S.-made products can qualify to form an IC-DISC. Good candidates include, but are not limited to:

• Traditional manufacturers, including both those that directly export their products and those that sell products that are destined for use overseas

• Producers of agriculture products, minerals, and/or software

• Distributors of U.S.-made goods

• Architectural and engineering firms who work on projects that will be constructed abroad

• Pass-through entities and privately-held corporations

WNDE IC-DISC ServicesWNDE’s team of tax professionals are thoroughly versed on IC-DISC implementation and maintenance. We are prepared to guide your organization in taking the most advantage of this tax incentive.


SECTION 199A PASS-THROUGH DEDUCTION

• Brokerage Services

• Investing and Investment Management

• Trading

• Dealing in Securities, Partnership Interests, or Commodities

• Any trade or business where the principle asset of such trade or business is the reputation or skill of one or more of its employees or owners.

• Health

• Law

• Accounting

• Actuarial Science

• Performing Arts

• Consulting

• Athletics

• Financial Services

WHO CAN (AND CAN’T) CLAIM SECTION 199A?

Section 199A allows for an up to 20% deduction from pass-through income for a domestic business that operates as either a:

• Sole proprietorship • Partnership • S corporation

The deduction is also allowed for the combined income of qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership (PTP) income.

As a rule, pass-through income from a specified service trade or business (SSTB) is excluded from the deduction, unless the taxpayer’s taxable income is below the aforementioned thresholds for joint and single filers. In general, an SSTB is defined as any trade or business performing services in one or more of the following fields:

Neither corporations nor employees can claim a QBI deduction.

WNDE Section 199A ServicesWhile the above information provides a general overview of the 199A pass-through deduction, the deduction is subject to a number of further regulatory guidelines and limitations. The 199A deduction is a valuable and worthwhile proposition for any qualifying entity to pursue, but it is a complex provision that requires a deep understanding of the new law. We strongly urge you to consult a knowledgeable tax advisor in order to address making changes to your tax planning strategy.

WNDE’s team of tax professionals are thoroughly versed on Section 199A requirements. We are prepared to guide your organization in taking the most advantage of this tax deduction.

WHAT IS SECTION 199A?

The Section 199A deduction for pass-through entities was signed into law as part of the Tax Cuts and Jobs Act (TCJA) of 2017. Just as the TCJA benefited C corporations by reducing the corporate tax rate, the new 199A deduction was created to provide similar tax relief for the nation’s small- and mid-size businesses by offering an up-to-20% deduction to pass-through entities.

HOW DOES IT WORK?

In its simplest form, the deduction is calculated off a specific income threshold for the taxpayer. If the taxpayer’s taxable income for the year is less than the $315,000 threshold ($157,500 for single filers), then the new deduction is calculated by the lesser of:

• 20% of qualified business income (QBI) or

• 20% of the overall taxable income of the individual

QBI is the net amount of qualified items of income, gain, deduction, and loss connected to a qualified U.S. trade or business. Think of it as the regular, non-investment income brought in by a business (within the U.S.). Only items included in taxable income are counted.

When a taxpayer’s income exceeds the threshold, certain limitations apply. If this occurs, the deduction will be limited to the lesser of:

• 20% of the taxpayer’s QBI or

• The greater of:

1. 50% of W-2 wages with respect to the business or

2. 25% of W-2 wages with respect to the business, plus 2.5% of the allocable share of unadjusted bases of all qualified property

Additionally, the business must not be considered a “specified service trade or business” (see below) and must either pay wages or own property. Taxpayers with taxable income below the threshold are not subject to limitations on the deduction and are not prevented from claiming the deduction on specified service trade or business income.


BONUS DEPRECIATION

WHAT IS BONUS DEPRECIATION?

Bonus depreciation, sometimes referred to as the additional first-year depreciation deduction, is a Federal tax incentive for businesses that purchase eligible assets, such as machinery. It allows the purchaser to deduct a large percentage of the purchase price of the eligible asset immediately, then write the remaining cost off over the useful life of that asset. Although some states follow the Federal bonus depreciation rules, California does not conform.

HOW DOES BONUS DEPRECIATION WORK?

When discussing bonus depreciation, it’s important to note that the 2017 Tax Cuts and Jobs Act (TCJA) made some major changes to bonus depreciation. As such, there is some regulatory variance between assets placed in service before and after September 27, 2017.

Bonus Depreciation Under Section 179For tax years 2015 through 2017, bonus depreciation is regulated by Section 179. Section 179 set first-year bonus depreciation at 50%, then scheduled it to decrease starting in 2018 and phase out entirely in 2020 and beyond. Under Section 179, in order for an asset to qualify for bonus depreciation, it must both:

1. Have a useful life of 20 years or less (this includes all types of tangible personal business property and software purchased, but not real property)

2. Be purchased from someone unrelated to the buyer (e.g., it can’t be a gift or inheritance)

Additionally, Section 179 only allows for bonus depreciation of new property.

Bonus Depreciation Under the Tax Cuts and Jobs ActThe TCJA made major changes to bonus depreciation regulations. The tax code update changed the allowable first-year bonus depreciation deduction for qualified property. Formerly 50%, the deduction was increased to 100% through 2022; after that, the amount of allowable bonus depreciation phases out over four years, as follows:

In order for an asset to qualify for bonus depreciation under the TCJA, it must meet the following requirements:

• Assets must be of a specified type (generally, this includes machinery, equipment, computers, appliances, and furniture).

• Assets must either be new or be used and meet the acquisition requirements of Section 168(k)(2)(E)(ii).

• Assets must have a recovery period that is less than or equal to 20 years.

• Assets must have been acquired and placed in service after September 27, 2017.

HOW TO CLAIM BONUS DEPRECIATION

Whether or not you will benefit from claiming bonus depreciation depends upon the specifics of your business and tax situation. Here’s a quick look at the methods for claiming (or not claiming) bonus depreciation.

To claim the deduction, business taxpayers should file Form 4562 Depreciation and Amortization with their business tax return. It is important that taxpayers retain copies of their filed 4562s in order to keep track of prior deductions and ensure that they claim the appropriate deduction on future tax returns.

Conversely, to opt out of the depreciation deductions for a class of property, taxpayers should do so on their tax return. Taxpayers who have already filed a return without making the election to opt out have six months from the original filing deadline to submit an amended return.

WNDE Bonus Depreciation ServicesWNDE’s team of tax professionals are thoroughly versed on bonus depreciation regulations, both under Section 179 and under the Tax Cuts and Jobs Act. We are prepared to guide your organization in taking the most advantage of this tax deduction.


YEAR(S) BONUS DEPRECIATION

Present-2022 100%

2023 80%

2024 60%

2025 40%

2026 20%

ABOUT WHITE NELSON DIEHL EVANS LLPWhite Nelson Diehl Evans LLP represents over 3,000 businesses and 3,500 individual clients. The firm provides a full range of accounting, tax and advisory services that support some of Southern California’s most successful and entrepreneurial companies, as well as governmental agencies and nonprofit organizations. For more information, visit www.wndecpa.com.

Documents

Advanced Tax Strategies...Advanced tax strategies covered in this eGuide include: To learn more about these strategic tax planning strategies, and how they might benefit your business