Tax Publications

Subscribe to Tax Publications feed
This is a feed of the latest BDO USA TaxPublications.
Updated: 13 hours 22 min ago

How to Avoid Common Missteps with Passive Foreign Investment Corporations (PFICs)

Thu, 07/06/2017 - 12:00am
BDO Tax Managing Partner Charles Barragato highlights common missteps with Passive Foreign Investment Corporations (PFICs) in the article Cleansing the PFIC taint: Planning and pitfalls. PFICs are an area of common tax missteps with missed elections. The default PFIC regime is not often advantageous for most clients. The article discusses how to remedy missteps and cleanse the PFIC “taint”.
BDO Insights
  • Taxpayers that hold PFIC stock are potentially subject to an additional tax on excess distributions unless they make a mark-to-market election or a qualified electing fund (QEF) election in the year PFIC stock is purchased.
  • If a taxpayer fails to make an election, the stock will always be considered PFIC stock, even in years when the company issuing the stock no longer qualifies as a PFIC.
  • A missed QEF election can be made in subsequent years but taxpayers would have to make a deemed-sale or deemed-dividend election to purge the PFIC taint for the stock.
 
For a detailed analysis of how to avoid common missteps with PFICs, contact Charles Barragato, Northeast Regional Leader for the Private Client Services practice.
Read the Full Article

Federal Tax Alert - June 2017

Wed, 06/28/2017 - 12:00am
Real Estate Professional - Substantiation of Participation in Activities  Download PDF Version
Summary Two recent Tax Court cases have examined substantiation of taxpayers’ qualification as real estate professionals.  On April 17, 2017, in the case of Zane W. Penley, et ux. v. Commissioner, TC Memo 2017-65, the Tax Court found that the documentation provided by the taxpayer did not prove the taxpayer worked more hours in his real estate business than in his full time employment. As such, the taxpayer was not a real estate professional and his rental real estate losses were subject to passive loss limitations and could not be deducted against his active income. Conversely, in Patricia S. Windham v. Commissioner, TC Memo 2017-68, the Tax Court held that the taxpayer was a real estate professional and her rental real estate losses were not subject to the passive activity loss limitations as she was able to credibly substantiate the amount of time she spent in her real estate business compared to her part-time employment. 
Details Background

Taxpayers are generally allowed to deduct business and investment expenses under sections 162 and 212, but section 469 puts strict limits on the deductibility of expenses incurred in a “passive activity.”[1] A passive activity is any trade or business in which the taxpayer does not materially participate.[2] Subject to a few exceptions, passive activity losses are deductible only to the extent of passive activity income. Individuals, trusts, estates, and personal service corporations may not use losses from passive activities to offset salary, dividends, interest, royalties, portfolio gains, and income from active business activities. Income and losses from rental activities are always considered passive unless the taxpayer is in the real property business (i.e., a “real estate professional”).[3] Special rules provided under section 469(c)(7) allow real estate professionals to deduct rental losses against other income provided that the taxpayer materially participates in the rental activity. Two requirements must be met for a taxpayer to be considered a real estate professional:
  1. More than one-half of the personal services performed in trades or businesses by the taxpayer during such taxable year are performed in real property trades or businesses in which the taxpayer materially participates, and 
  2. Such taxpayer performs more than 750 hours of services during the taxable year in real property trades or businesses in which the taxpayer materially participates. 
Recent Court Cases - Overview

In Zane W. Penley, et ux. v. Commissioner, Mr. Penley was employed full-time in a profession that was not a real property trade or business in which he spent 2,194 hours working during 2012. In addition to his full time employment, Mr. Penley and his wife participated in various rental real estate activities through a subchapter S corporation, Harvey Herbet, Inc. (“HHI”), in which they each owned 50 percent.  In the course of managing HHI’s affairs, Mr. Penley and his wife spent time finding tenants, managing finances, and making repairs to their real estate properties. Mr. Penley and his wife filed a joint tax return for 2012 on which they reported a nonpassive loss that was passed through from HHI. Upon examination by the Internal Revenue Service (“IRS”), it was determined that a portion of this loss was a passive loss from rental real estate activities and that Mr. Penley did not qualify as a real estate professional under section 469(c)(7).

The taxpayer in Windham v. Commissioner was a part-time stock broker who also owned and managed 12 rental real estate properties during 2010. The taxpayer managed all aspects of her rental properties including finding tenants, collecting rent, and coordinating repairmen when repairs were needed. In addition to her managerial duties, the taxpayer maintained insurance on each rental property, maintained services and upkeep on vacant rental properties, maintained records for each rental property, and completed the necessary documents for her certified public accountant to prepare her Federal income tax returns. The Tax Court determined that the taxpayer in this case qualified as a real estate professional and was allowed to deduct losses on her rental real estate properties.  
 
Substantiation

A taxpayer can use “any reasonable” means to prove the extent of their participation in real estate activities. In addition to contemporaneous daily time reports, logs, or similar documents, reasonable means may include identifying the services performed over a period of time and the approximate number of hours spent performing such services by using appointment books, calendars, or other narrative summaries.[4] In order to substantiate his treatment as a real estate professional, Mr. Penley provided a monthly calendar indicating he spent approximately 2,520 hours on his real estate activities during 2012. This calendar contained information pertaining to the property where he worked on a particular day and a brief description of the work performed, an estimate of the number of hours worked, and the number of miles driven to and from the property. The Tax Court found that the calendar provided by Mr. Penley greatly exaggerated the time he spent on his real estate activities. As Mr. Penley represented working approximately 2,520 hours on real estate activities in 2012, the Tax Court noted that he would have had to work approximately 4,714 hours (i.e., 2,194 for his full-time employment and 2,520 on real estate activities) during 2012 to account for the total amount of time that he claimed to have worked. The Tax Court further commented that Mr. Penley would have had to work approximately 13 hours per day, every day, for the hours provided to reconcile. In addition to the issues with respect to the number of hours worked, the Tax Court also found that the calendar provided by Mr. Penley was unreliable due to the fact that substantially all of the entries were rounded to the nearest hour or half-hour, did not specify a start or end time for work, did not include the time spent driving to and from his properties, and did not separate out any time for meals or other breaks. Even though contemporaneous records are not required for substantiation purposes, the courts have previously found that the use of post-event “ballpark guesstimate” is not sufficient to prove participation in a real estate activity.[5] Accordingly, the Tax Court determined that the calendar was untrustworthy and disallowed it as substantiation for treatment of Mr. Penley as a real estate professional. Consequently, Mr. Penley did not satisfy the requirements to be considered a real estate professional and the nonpassive loss claimed by Mr. Penley and his wife related to the rental real estate activities was disallowed.

Contrary to Penley v. Commissioner, the taxpayer in Windham v. Commissioner was able to provide information that the Tax Court deemed credible to substantiate her treatment as a real estate professional.  This was due in large part to the documentation and the testimony that the witness provided to the Tax Court. In addition to this information, the Tax Court noted that she only worked part-time in her stock brokerage office and examined additional facts surrounding the taxpayer and her real estate activities. As a result of downturns in the economy that occurred in the mid-2000s, the taxpayer withdrew approximately $180 thousand from her retirement account in 2010 to meet her rental real estate business expense requirements. The Tax Court took notice to the considerable amount of time and money that was spent by the taxpayer to keep her rental real estate activities afloat. After reviewing all of the information available, the Tax Court ultimately concluded that the taxpayer substantiated her participation in the activities as a real estate professional and could deduct the losses from her rental real estate properties.
  BDO Insights Taxpayers involved in rental real estate activities are encouraged to practice reasonable means when substantiating their participation in an activity. Substantiation is increasingly important for taxpayers who wish to qualify as real estate professionals pursuant to Section 469(c)(7). Taxpayers should be encouraged to maintain contemporaneous daily time reports, logs, or similar documentation.  However, in the absence of contemporaneous daily time reports or logs, taxpayers may use other reasonable means of tracking the amount of time spent and the services performed for an activity such as through the use of appointment books, calendars, or other narrative summaries. Taxpayers should always use caution that the documentation created is credible to avoid future challenges of the documentation. Even though contemporaneous documentation is not required for substantiation under the regulations, it is strongly recommended and considered a best practice.

 
For more information on matters discussed above, please contact: 
  David Patch
Tax Managing Director   Jeff Bilsky
Tax Partner    Julie Robins
Tax Managing Director   Will Hodges
Tax Manager    
[1] Unless otherwise indicated, all “section” references herein are to the Internal Revenue Code of 1986, as amended, and all “Treas. Reg. §” references are to the Treasury regulations promulgated thereunder.
[2] Section 469(c)(1)
[3] Section 469(c)(2); Section 469(c)(7)
[4] Treas. Reg. Sec. 1.469-5T(f)(4)
[5] Fowler v. Commissioner, TC Memo 2002-223

State and Local Tax Alert - June 2017

Wed, 06/21/2017 - 12:00am
Oklahoma Establishes Voluntary Disclosure Initiative, Modifies VDA Program, and Establishes New Enforcement Division
Summary During the month of May, Oklahoma enacted several bills related to amnesty programs and voluntary disclosure agreements.  H.B. 2380 establishes a “Voluntary Disclosure Initiative” for all Oklahoma tax types, with a waiver of penalties and interest, between September 1, 2017 and November 30, 2017.  H.B. 2252 amends Oklahoma’s voluntary disclosure agreement program.  H.B. 1427 creates an “Out-of-State Tax Collections Enforcement Division.”
  Details Voluntary Disclosure Initiative
 
On May 24, 2017, H.B. 2380 was signed into law by the Oklahoma Governor.  The enacted legislation authorizes the Oklahoma Tax Commission to establish a “Voluntary Disclosure Initiative,” i.e., an amnesty program, for the following eligible taxes: mixed beverage tax, gasoline and diesel tax, gross production and petroleum excise tax, sales and use taxes, corporate and personal income taxes, and personal withholding tax.
 
Eligible taxpayers are entitled to a waiver of penalties, interest, and other collection fees due on eligible taxes if the taxpayer voluntarily files delinquent tax returns and pays the taxes due during the disclosure initiative.  The time period to participate in the Voluntary Disclosure Initiative is limited to the period beginning September 1, 2017, and ending November 30, 2017.
 
To be eligible to participate in the Voluntary Disclosure Initiative, taxpayers must meet all the following requirements:
 
  1. The taxpayer must not have outstanding tax liabilities, other than those reported pursuant to this initiative;
  2. The taxpayer must not have been contacted by the Oklahoma Tax Commission, or a third party acting on behalf of the Commission, with respect to the taxpayer’s potential or actual obligation to file a return or make a payment to the state;
  3. The taxpayer must not have collected taxes from others, such as sales and use taxes or payroll taxes, and not reported those taxes; and
  4. The taxpayer must not have, within the previous three years, entered into a voluntary disclosure agreement for the tax type owed.
 
If the taxpayer meets the eligibility requirements listed above, then the look-back period will be limited to three years for annually filed returns and 36 months for taxes that do not have an annual filing frequency.
 
If the taxpayer does not meet the third requirement (e.g., taxpayer has collected sales taxes, however did not remit them to the state), but meets the other eligibility requirements, then it may enter into a “modified voluntary disclosure agreement.”  Under the terms of the modified VDA, the taxpayer will receive the same benefits as listed above, except for the waiver of interest, unless optionally granted at the discretion of the Tax Commission.  Additionally, the period for which taxes must be reported and remitted will be extended to include all periods in which tax has been collected but not remitted.
 
Amendments for Voluntary Disclosure Agreements
 
On May 19, 2017, H.B. 2252 was signed into law by the Oklahoma Governor, and it becomes effective November 1, 2017.  This legislation amends Oklahoma’s voluntary disclosure agreement provisions, under 68 O.S. § 220.  To be eligible to enter into a voluntary disclosure agreement, the taxpayer must meet the same four requirements (above) for eligibility to participate in the “Voluntary Disclosure Initiative.”
 
If the Tax Commission agrees with the proposed terms of the VDA, then penalties will be waived and 50 percent of interest will be waived.  The look-back period will be limited to three years for annually filed returns and 36 months for taxes that do not have an annual filing frequency.
 
As with the Voluntary Disclosure Initiative, if the taxpayer does not meet the third requirement, but meets the other eligibility requirements, then the taxpayer may enter into a “modified” VDA.  Under the modified VDA, interest will not be waived and the look-back period will be extended to tax periods where tax was collected, but not remitted.
 
Out-of-State Collections Enforcement Division
 
On May 10, 2017, H.B. 1427, “Out-of-State Tax Collections Enforcement Act of 2017,” was signed into law by the Oklahoma Governor, and it becomes effective November 1, 2017.  The legislation authorizes the Oklahoma Tax Commission to establish an “Out-of-State Tax Collections Enforcement Division.”  The purpose is to enhance (1) sales and use tax collections related to sales involving residents of Oklahoma and out-of-state vendors with nexus in Oklahoma, and (2) collections of any other unpaid taxes by out-of-state individuals, firms, or corporations.  It also allows the Tax Commission to contract with out-of-state private auditors or audit firms.
  BDO Insights
  • Oklahoma’s voluntary disclosure initiative presents a great opportunity for a taxpayer to come into compliance with their Oklahoma taxes, and reduce related accounting reserves, if any, without having to pay penalties or interest.
  • The Tax Commission publishes a list on its website of its top 100 delinquent taxpayers, including the name, address, tax type, and delinquency amount of each such taxpayer.  Thus, this tax amnesty may also present a taxpayer having a large tax delinquency with the opportunity to come into compliance with their Oklahoma taxes at a much lower cost and avoid tarnishing their reputation by appearing on this list or even remove their name from the list.
  • The amnesty program is expected to increase revenue by $14.6 million in 2018, comprised of $10.2 million related to sales taxes and $4.4 million related to withholding taxes.
 
For more information, please contact one of the following regional practice leaders:
  West:   Atlantic: Rocky Cummings
Tax Partner
    Jeremy Migliara
Tax Managing Director
  Paul McGovern
Tax Managing Director   Jonathan Liss
Tax Managing Director   Northeast:   Central: Janet Bernier 
Tax Partner
    Angela Acosta
Tax Managing Director
  Matthew Dyment
Tax Principal
    Nick Boegel
Tax Managing Director
 
Southeast:   Joe Carr
Tax Partner
  Scott Smith
Tax Managing Director
    Mariano Sori
Tax Partner
  Tony Manners
Tax Managing Director
    Richard Spengler
Tax Managing Director
 






   
Southwest:
Gene Heatly
Tax Managing Director

Tom Smith
Tax Partner
 

State and Local Tax Alert - June 2017

Mon, 06/19/2017 - 12:00am
What Every Business Should Know About Delaware Unclaimed Property SB13 & Corresponding Regulations Should your company be participating in the Delaware SOS VDA program?

Launched in 2012, the VDA Program was created to address concerns about Delaware’s ongoing unclaimed property audit program and to encourage more companies to comply with their legal responsibilities as they relate to abandoned property.
 
The program is designed to make abandoned and unclaimed property compliance for Delaware companies cheaper, faster and easier. To date, more than 800 companies have enrolled, and more than 400 VDAs have been settled. The process is rigorous, but fair, and it provides Delaware corporations with a more predictable and efficient means of coming into compliance.
 
To learn more, BDO USA, LLP's SALT practice invites you to listen to, What Every Business Should Know About DE Unclaimed Property SB13 & Corresponding Regulations, an informative webinar featuring the Honorable Jeffrey Bullock from Delaware Department of State and Geoffrey Sawyer from Drinker Biddle & Reath LLP.

If your company is uncertain if it is compliant with its obligations under the law, then this webinar can assist you in identifying the appropriate steps for reconciliation. Failure to address your company’s unclaimed property compliance can potentially lead to liabilities, including interest and penalties in multiple jurisdictions.
 
In this presentation, you will learn:
  • What the SOS VDA program is and why it was enacted
  • What types of companies fall under the program purview
  • A step-by-step approach for converting an audit to a VDA
  • How Delaware’s latest rule proposals should impact your firm’s approach


This is the second webinar in a two-part series designed to help you learn more about the latest changes to Delaware's unclaimed property laws, how they will impact your business and what you can do to stay ahead of them. You can also listen to part one, Updates on Delaware Unclaimed Property Regulations, recorded on Feb. 21, 2017.


About the Delaware SOS VDA Program

 
At its core, the DE VDA program is a settlement program, enabling the holder of unclaimed property to manage the VDA process and present its findings to the State for validation. After entering and completing the program, holders that fulfill their future annual reporting requirements are protected against an unclaimed property audit for historic liabilities for the property types and entities reviewed as part of the SOS VDA.
 
The program was designed to assist companies with reaching a final agreement on past due liabilities as quickly as possible. It was also designed to provide a lower cost solution that enables a company to come into 50-state compliance in a more business friendly and collaborative manner. The program assesses no interest and penalties, and gives a holder certainty regarding past due liability.
 

Common questions about DE unclaimed property laws

 
My company is a Delaware corporation, but has no operations in the state. What unclaimed property laws apply?

  • In general, the laws of states where your company has operations and Delaware law will apply. This is because under the sourcing rules laid out in Texas v. New Jersey, holders source unclaimed property first to the state of last known name and address on their books and records. If no address is known, the unclaimed property is reported and remitted to the holder's state of domicile (e.g., state of incorporation or formation). 
  • Given these rules and current state practice, for those years where actual address property is determined (e.g., base period) one would report any unclaimed property due and owing to that state. For years outside the base period (e.g., projection period) there is an estimation back to the end of the look-back period (currently 15 transaction years in Delaware).  
Does Delaware require negative reporting?
  • No. The statute of limitations provision was changed such that the statute begins to run when the duty to report is triggered, so holders no longer have to file a negative report to commence the running of the statute of limitations.
How does the new statute of limitations provision differ from the old?
  • The old statute of limitations provision would not begin running until a holder filed a report, even a negative report. As such, the state could conduct an audit of company within the new SOL period. This is mitigated somewhat if a company has a robust filing history or has filed VDAs in the states where it has escheat obligations.
 


For more information, visit: https://legis.delaware.gov/BillDetail/25389

State and Local Tax Alert - June 2017

Fri, 06/09/2017 - 12:00am
Connecticut Combined Filers Net Deferred Tax Liability Deduction Deadline is set for July 3rd  
Summary Connecticut combined filers have a right to claim and deduct a net deferred tax liability, but must first file a Statement of Net Deferred Tax Liability Deduction with the Connecticut Department of Revenue Services by July 3, 2017, or they will lose the right to claim the deduction.  No extensions will be granted to file the statement. 
Details  Connecticut enacted legislation in 2015 (H.B. 7061 and S.B. 1502) requiring companies to calculate their Corporation Business Tax on a unitary combined reporting basis, effective for tax years beginning on or after January 1, 2016, as well as adopting a provision allowing for the deduction for a net deferred tax liability (Conn. Gen. Stat. §§12-218e and 12-218f).  The deduction is claimed by filing a Statement of Net Deferred Tax Liability Deduction with the Department of Revenue Services.  The deadline for claiming the deduction is currently set for July 3, 2017.  The Department of Revenue Services is not granting extensions to the deadline. 
 
As a result of enacting a unitary combined reporting requirement, certain taxpayers may have been required to adjust their deferred tax assets and/or liabilities on financial statements as a result of the legislation.  In order to offset any negative effect that the legislation may have imposed on combined unitary taxpayers’ financial statements, a deduction is permitted.  The deduction is allowed if Connecticut’s adoption of unitary combined reporting results in: 
 
1) An increase to a taxpayer’s net deferred tax liability (DTL);
2) A decrease to a taxpayer’s net deferred tax asset (DTA); or
3) Causes a net DTA to become a net DTL. 
 
The amount of the Net Deferred Tax Liability Deduction is equal to the amount necessary to offset the balance sheet impact of such changes and may be taken in seven equal installments over a seven year period beginning with income year 2018.  Special Notice 2016(1)  and OCG-2 were issued and provide additional details and examples for computing the deduction. 
BDO Insights
  • Statements must be filed with the Commissioner of Revenue Services on or before July 3, 2017.  No extensions of time will be granted.  A completed Statement of Net Deferred Tax Liability Deduction must be completed and mailed, with all supporting documentation, to the Department of Revenue Services on or before July 3, 2017.
  • Taxpayers affected by the July 3, 2017 deadline to claim the Connecticut Net Deferred Tax Liability Deduction should consult with their financial statement auditor and tax advisor to evaluate and determine the potential financial statement implications under ASC 740, including the impact on current and deferred taxes, uncertain tax benefits, and disclosures.
 


For more information, please contact one of the following regional practice leaders:
 

West:   Atlantic: Rocky Cummings
Tax Partner
    Jeremy Migliara
Tax Managing Director
  Paul McGovern
Tax Managing Director   Jonathan Liss
Tax Managing Director   Northeast:   Central: Janet Bernier 
Tax Partner
    Angela Acosta
Tax Managing Director
  Matthew Dyment
Tax Principal
    Nick Boegel
Tax Managing Director
 
Southeast:   Joe Carr
Tax Partner
  Scott Smith
Tax Managing Director
    Mariano Sori
Tax Partner
  Tony Manners
Tax Managing Director
    Richard Spengler
Tax Managing Director
 






   
Southwest:
Gene Heatly
Tax Managing Director

Tom Smith
Tax Partner
 

Federal Tax Alert - June 2017

Thu, 06/08/2017 - 12:00am
IRS Issues Clarifying Guidance on the PATH Act Changes to Section 179 and Bonus Depreciation
Summary The Protecting Americans from Tax Hikes Act of 2015 (“PATH Act” or “The Act”) included amendments and changes to §§179, 168(k), and 168(j). The changes made in The Act are effective for property placed in service in taxable years beginning in 2016. A major impact of The Act is the creation of a new category of qualified property, called qualified improvement property, eligible for the additional first-year depreciation deduction (bonus depreciation) under §168(k). The IRS recently issued Revenue Procedure 2017-33, which provides guidance and examples to clarify the application of the qualified improvement property classification, as well as guidance on other changes made to §§179, 168(k), and 168(j) by The Act.
Background On December 18, 2015, Congress enacted the PATH Act (P.L. 114-113). 
 
Section 179(a) allows a taxpayer to elect to treat the cost (or a portion of the
cost) of any §179 property as an expense for the taxable year in which the taxpayer
places the property in service. The Act amended §179 by:
 
  1. making permanent the treatment of qualified real property as §179 property under § 179(f),
  2. making permanent the permission granted under §179(c)(2) to revoke without consent of the Commissioner of Internal Revenue any election made under §179 and any specification contained in that election, and
  3. allowing certain air conditioning or heating units to be eligible as §179 property under §179(d)(1).
 
Prior to amendment by the PATH Act, §168(k)(1) allowed a 50-percent additional first year depreciation deduction for qualified property that was acquired by a taxpayer after 2007 and placed in service by the taxpayer before 2015 (before 2016 in the case of certain long production period property and certain noncommercial aircraft). The Act amended §168(k) by:
 
  1. extending the bonus depreciation allowance to qualified property placed in service before January 1, 2020 (or before January 1, 2021, in the case of certain long production period property and certain noncommercial aircraft),
  2. modifying the definition of qualified property under §168(k)(2),
  3. extending and modifying the election under §168(k)(4) to increase the alternative minimum tax (AMT) credit limitation, in lieu of the additional first year depreciation deduction (Rev. Proc. 2017-33 does not include guidance on this section),
  4. adding §168(k)(5), which allows a taxpayer to elect to deduct the additional first year depreciation for certain plants bearing fruits and nuts before such plants are placed in service,
  5. adding §168(k)(6), which provides a phase down of the additional first year depreciation deduction percentage for future taxable years, and
  6. adding §168(k)(7), which allows a taxpayer to elect not to deduct additional first year depreciation for any class of property.
 
Internal Revenue Code §168(j) – Property on Indian reservations, provides the applicable recovery periods for qualified Indian reservation property and special rules pertaining to such property. The Act amended §168(j) by adding §168(j)(8), which allows a taxpayer to elect not to apply §168(j) for any class of property
 
The IRS issued Rev. Proc. 2017-33 to provide guidance on the changes made by The Act in response to taxpayer questions regarding these changes. The revenue procedure does not reflect any proposed technical corrections to The Act. The following discussion briefly highlights certain key points discussed in Rev. Proc. 2017-33. Rev. Proc. 2017-33 is effective as of April 20, 2017.
 
Air Conditioning Units Qualifying as §179 Property
 
Rev. Proc. 2017-33 clarifies that, in addition to portable air conditioning or heating units meeting the requirements to be classified as §179 property, if a component of a central air conditioning or heating system meets the definition of qualified real property, as defined in §179(f)(2), and the component is placed in service by the taxpayer in a taxable year beginning after 2015, the component may qualify as §179 property if the taxpayer elects to apply §179(f).
 
As provided in §179(f)(2), qualified real property includes qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property.
 
Acqusition Date Requirement for Qualified Property 
 
Qualified property described under §168(k)(2)(A) no longer has to meet the acquisition date requirements in §168(k)(2)(A)(iii) that were in effect prior to the enactment of The Act. Property acquired after December 31, 2007, and before January 1, 2020, that meets all other requirements of §168(k), is qualified property.
 
Note that The Act imposes a new acquisition date requirement for property described in §168(k)(2)(B) and (C) (i.e. long production period property and certain aircraft). 
 
Placed-In-Service Date Requirement for Qualified Improvement Property 
 
Qualified improvement property is defined in §168(k) as “any improvement to an interior portion of a building which is nonresidential real property if such improvement is placed in service after the date such building was placed in service.”
 
The term “first placed in service” means the first time the building is placed in service by any person.
 
Rev. Proc. 2017-33 provides several examples illustrating that improvements placed in service any time after the building is placed in service, even one day later, can qualify for bonus depreciation. This includes the initial build out of tenant spaces in a commercial rental building as discussed in example 4 of the revenue procedure.
 
Qualified Restaurant Property 
 
Qualified property that is placed in service by the taxpayer after December 31, 2015, and that meets the definition of both qualified improvement property and qualified restaurant property, as defined in §168(e)(7), is eligible for the additional first-year depreciation deduction under §168(k), assuming all other requirements in §168(k) are met.
 
Rev. Proc. 2017-33 provides two examples illustrating when qualified restaurant property is, or is not, also qualified improvement property.
 
Phase Down of Additional First-Year Depreciation Percentage 
 
Two tables in Rev. Proc. 2017-33 provide the additional first-year depreciation deduction percentages for qualified property placed in service by the taxpayer after 2015 and before 2020 (2021 for property described in §168(k)(2)(B) or (C)). The first table addresses property that is not described in §168(k)(2)(B) or (C) and the second table addresses property that is described in §168(k)(2)(B) or (C) (i.e. long production period property and certain aircraft).
 
Other Guidance Provided by Rev. Proc. 2017-33
 
In addition to the guidance addressed above, Rev. Proc. 2017-33 provides guidance for other areas of §§179, 168(k), and 168(j) affected by The Act, including making §179 elections by amended returns, rules for making the election under §168(k)(7) not to deduct the additional first-year depreciation deduction, special rules for certain plants bearing fruits and nuts and the §168(k)(5) election for a specified plant, and the §168(j)(8) election not to apply §168(j).
  BDO Insights Taxpayers should be aware of all the requirements to take advantage of the qualified improvement property asset classification. Due to the fact that qualified improvement property is eligible for the additional first-year depreciation deduction, proper application of the qualified improvement property classification can provide an opportunity for substantial depreciation deductions in certain situations.

The Cost Segregation Services team within the BDO Fixed Assets Advisory Services group consists of professionals experienced in building design, construction, cost estimating, and relevant tax authority and can help owners of business real estate assets increase cash flow by accelerating federal tax depreciation through engineering-based cost segregation studies. The Accounting Methods group within BDO USA’s National Tax Office has extensive experience assisting taxpayers of all industries and sizes with their accounting method issues and filing accounting method change requests with the Service.
 
For more information on matters discussed above, please contact: 

Fixed Assets Advisory Services Group
  Daniel Fuller   Duane Dunlap   Mark Zettell    
National Tax Office Accounting Methods Group
  Dave Hammond   Marla Miller    Yuan Chou    

State and Local Tax Alert - June 2017

Wed, 06/07/2017 - 12:00am
New York City Department of Finance Issues Statement of Audit Procedure Clarifying Treatment of Federal Partnership Step-up Adjustments for Unincorporated Business Tax Purposes
Summary On May 5, 2017, the New York City Department of Finance (“DOF”) issued a Statement of Audit Procedure UBT-2017-1 (the “SAP”), addressing the application of tax basis adjustments under Internal Revenue Code (“IRC”) Sections 734 and 743 to the New York City Unincorporated Business Tax (“UBT”). The SAP reaffirms the understanding that tax basis step-up adjustments arising from transactions governed by Section 743(b) do not impact the computation of a partnership’s NYC unincorporated business taxable income (“UBTI”). However, the SAP clarifies that the UBT conforms to the federal deductions resulting from tax basis step-up adjustments under Section 734(b).
Details Background
NYC imposes the UBT on entities taxed as partnerships for federal income tax purposes, and the terms used in the IRC will generally have the same meaning for UBT purposes unless a different meaning is clearly required. Thus, a partnership’s UBTI is generally the same as its federal taxable income prior to UBT modifications. The SAP explains that the “UBT does not include any specific statutory modification to the federal calculation of basis for the purposes of determining UBTI.” 

For federal income tax purposes, if an election under Section 754 is executed, or if the transaction would result in a substantial basis reduction, a partnership is required to adjust the tax basis of partnership assets (upward or downward) to the respective fair market value of the assets. The effect of this basis adjustment is to equalize discrepancies between the partner’s “outside” tax basis in the partnership interest as compared to the partner’s share of the partnership’s tax basis in the partnership assets, i.e., “inside” tax basis. The nature of the transaction that gives rise to the basis adjustment dictates whether the basis adjustment is determined under Section 734(b) or Section 743(b).
 
Prior to the SAP, partnerships subject to the UBT had minimal guidance to rely upon when reporting Section 743(b) basis adjustments, and no guidance with respect to Section 734(b) basis adjustments. One court case, Dolly Company v. Tully, 65 A.D. 2d 99 (N.Y. App. Div. 3d Dep’t 1978), held that a partnership could not consider the basis adjustments allowable under Section 743(b) in calculating its New York State unincorporated business tax, a tax that New York State repealed effective December 31, 1982. The court’s decision in Dolly Company did not address Section 734(b). Partnerships could find additional guidance in the DOF’s instructions to NYC Form 204, Unincorporated Business Tax Return for Partnerships (including Limited Liability Companies), stating that a partnership that makes an election under Section 754 may not adjust the basis of its assets on the sale or purchase of an interest in the partnership. However, the reference to “sale or purchase of an interest in the partnership” is ambiguous as to whether the UBT disallowed any tax benefits resulting from basis step-ups governed under both Sections 734 and 743. This is because gain recognized on a distribution that creates a Section 734(b) adjustment is considered gain on the disposition of a partnership interest potentially captured as not permitted under the verbiage in the instructions to the Form. 

Section 743(b)
Basis adjustments under Section 743(b) may arise in the case of a transfer of an interest in a partnership by sale or exchange, or upon the death of a partner. Basis adjustments can be allocated to the assets of the partnership, including fixed assets or goodwill, and such adjustments are deemed to be attributed to the purchasing or inheriting partner only. Therefore, the depreciation and amortization deductions arising from the step-up adjustments are specially allocated to the transferee partner and do not otherwise affect the partnership’s calculations of income, gain, loss and deduction.

Section 734(b)
Under Section 734(b), a tax basis step-up is recognized in the case of a distribution of money or property to a partner by a partnership. In the case of a distribution of money, a basis step-up is recognized as a result of a distribution of money in excess of the partner’s outside tax basis, including his/her share of partnership liabilities. A step-up may also be recognized when the partnership distributes property whereby the receiving partner takes a basis in the property that is less than the distributing partnership’s inside basis in the property. In these situations, the step-up is recognized by the partnership as an asset of the partnership, rather than attributed to one partner specifically.

Clarification by the SAP
The SAP clarifies that basis adjustments under Section 734(b) are permissible when computing NYC UBTI because, under the IRC, the Section 734 basis adjustments are considered partnership assets and affect the partnership’s subsequent calculations of income, gain, loss, and deduction, which then flow through to its UBTI. The SAP also provides examples to illustrate this point.

The SAP also indicates that the DOF will follow the federal allocation of basis adjustments, which result when comparing the fair market value to tax basis of partnership assets.

In addition, the SAP notes that the DOF will follow the federal treatment of disguised sales, which generally result in step-up adjustments under Section 743(b) and would not result in deductible amortization for UBT purposes. Finally, the DOF indicated that it will also follow the Federal tax treatment of entity conversions “to” or “from” partnership form under either Revenue Ruling (“Rev. Rul.”) 99-5 or Rev. Rul. 99-6.

Rev. Rul. 99-5 provides guidance with respect to the income tax treatment of the conversion of an entity wholly-owned by one party, and treated as disregarded, to a multi-owner entity treated as a partnership. Rev. Rul. 99-6 describes two situations in which a multi-owner entity treated as a partnership for income tax purposes is converted to a single-owner entity treated as disregarded. In either case, basis step-ups under Sections 734 or 743 are not generally produced. The purchaser in each transaction is deemed to acquire assets under Sec. 1001 and as a result is permitted a cost basis in the acquired assets under Sec. 1012 equal to their purchase price, effectuating a step-up in basis to fair value.
BDO Insights
  • The clarification as to how Federal tax basis adjustments apply to the UBT is a favorable development for taxpayers, as the SAP permits additional deductions for items that were previously thought to be non-deductible in calculating UBTI.
  • Because SAPs merely reflect the DOF’s interpretation of the law and do not have the effect of laws or regulations, taxpayers should work with their tax advisers to determine whether a position reaches substantial authority, thus not requiring disclosure.
  • Taxpayers may consider amending previously filed returns, as permissible, in order to claim missed deductions.
  • Tax advisers should be mindful of these potential deductions on future NYC UBT returns.
  • Taxpayers affected by the DOF’s issuance of this SAP should consult with their financial statement auditor and tax advisor to evaluate and determine the potential financial statement implications under ASC 740, including the impact on current and deferred taxes, uncertain tax benefits, and disclosures.
   

For more information, please contact one of the following regional practice leaders:
 

West:   Atlantic: Rocky Cummings
Tax Partner
    Jeremy Migliara
Tax Managing Director
  Paul McGovern
Tax Managing Director   Jonathan Liss
Tax Managing Director   Northeast:   Central: Janet Bernier 
Tax Partner
    Angela Acosta
Tax Managing Director
  Matthew Dyment
Tax Principal
    Nick Boegel
Tax Managing Director
 
Southeast:   Joe Carr
Tax Partner
  Scott Smith
Tax Managing Director
    Mariano Sori
Tax Partner
  Tony Manners
Tax Managing Director
    Richard Spengler
Tax Managing Director
 






   
Southwest:
Gene Heatly
Tax Managing Director

Tom Smith
Tax Partner
 

International Tax Alert - June 2017

Wed, 06/07/2017 - 12:00am
The Indian Tiffin XIV A bi-monthly publication from BDO India, "The Indian Tiffin" brings together business information, facilitating decision-making from a multi-dimensional perspective. The unique name of this thought leadership piece is inspired most literally by Indian tiffins, referring to home cooked lunches delivered to the working population by 'dabbawalas' – people who deliver the packed lunches (tiffins). In that same sense, the purpose of “The Indian Tiffin” newsletter is to deliver a variety of news to satiate your palate, from domestic and cross-border updates to India business perspectives. This issue covers:
 
  • India Economic Update by Milind S.Kothari, Managing Partner, BDO India LLP.  The Update outlines the government’s three year performance in light of key economic reforms under Prime Minister Mr. Narenda Modi’s led National Democratic Alliance.
  • Learn about deal announcements in the M & A Tracker from Rajesh Thakkar, Partner, Transaction Tax /Tax & Regulatory Services.  Hear about 110 M&A deals that were announced and/or completed between April 2017, and May 2017, with an aggregated value of approximately $3.59 billion USD, the sectors the deals came from, and targeted companies.
  • In the Featured Story, Akshay Garkel, Partner, IT Advisory/Risk Advisory Services, takes a sectoral-dive into cyber threats for the insurance sector, elaborating on the security framework for insurers.
  • The Guest Column features Sameer Saxena, the Managing Director of SMG Information Security Media Group, India.  SMG is one of the fastest growing security professionals’ community talking about assessing risk metrics as the first step to making business-critical information, cybersecure.
  View the Newsletter

​BDO World Wide Tax News – June 2017

Wed, 06/07/2017 - 12:00am
The June 2017 issue of the World Wide Tax Newsletter, published by BDO International, summarizes recent tax developments of international interest around the world including: Trump Administration’s outline for Tax Reform in the U.S., Amendments to Tax Law by Finance Act 2017 for India, New Transfer Pricing documentation Requirements in India, and a host of other articles of interest for another 14 countries.
  View the Newsletter

Expatriate Tax Newsletter - May 2017

Tue, 05/30/2017 - 12:00am
BDO's Expatriate Newsletter covers timely tax-related updates and regulations from countries around the globe. The May 2017 issue highlights developments in Australia, Hong Kong and Macau, India, Ireland, Italy, The Netherlands and Switzerland.

Topics include:
  • Australia - Proposed legislative changes impacting both employers and the individual
  • Hong Kong and Macau - Upcoming amendment to the statutory minimum wage rate in 2017
  • India - India/Germany social security agreement
  • Ireland - Travel and subsistence
  • Italy - Italy welcomes new residents with an annual flat tax for foreign income
  • The Netherlands - 30% Ruling - Discount after 10 years away or after 25 years away?
  • Switzerland - Appeal for the safety clause concerning employees from Eu-2 countries (Bulgaria and Romania)

Download

BDO Transfer Pricing Alert - May 2017

Thu, 05/25/2017 - 12:00am
Court Delivers Prime Ruling for Amazon On March 23, the United Sates Tax Court ruled in Amazon.com, Inc. & Subsidiaries v. Commissioner of Internal Revenue in favor of the taxpayer.  The IRS had argued that Amazon undervalued its intangible property (“IP”) and applied a $1.5 billion adjustment to the taxpayer’s income, but the court ruled that the IRS acted arbitrarily or capriciously in applying the cost sharing regulations.[1] The case is a major ruling in favor of corporations that hold IP abroad and may serve as a significant precedent for future transfer pricing litigation.
Background In 2005, Amazon entered into a cost sharing arrangement (“CSA”) with its subsidiary in Luxembourg (“Subsidiary”) that permitted the Subsidiary to use pre-existing intangibles required to operate Amazon’s European website business.[2] A CSA is an agreement under which related parties agree to share the intangible development costs (“IDCs”) in proportion to their shares of reasonably anticipated benefits of the developed intangibles.  When one participant (here, Amazon) makes pre-existing IP available for the purposes of research under a CSA, that party is deemed to have transferred a property interest to the other CSA participant.  To complete the acquisition, the other participant (here, Subsidiary) must make a “buy-in payment” for the value of the IP to Amazon.

Amazon sought to act in accordance with the parameters for a CSA under the transfer pricing regulations.  Under Treas. Reg. Section 1.482-7, the Subsidiary was required to make a buy-in payment and then compensate Amazon annually for ongoing IDCs, which included research, development, marketing, and other activities relating to maintaining, improving, enhancing, or extending the intangibles.  According to the CSA, the Subsidiary would assist, by way of financial contribution only, in the ongoing development of technology required to operate the European websites and related activities.  The regulations further required Amazon to allocate the costs to the Subsidiary on a reasonable basis.  Therefore, Amazon developed a formula and applied it to allocate a portion of the costs accumulated in various cost centers to the IDCs to satisfy this criteria.[3]

During 2005 and 2006, Amazon transferred three groups of IP to its Subsidiary in a series of transactions including: the software and other technology required to operate its European websites, fulfillment centers, and related business activities; marketing intangibles, including trademarks, tradenames, and domain names relevant to the European business; and customer lists and other information relating to its European clientele.
IRS Stance The IRS challenged the Petitioner’s buy-in payment and applied a discounted cash flow (“DCF”) methodology to value the IP.  The IRS valued the IP at $3.6 billion, which starkly contrasted Amazon’s $254.5 million valuation.[4] The cause of the disparate conclusions was the contrasting assumptions over the IP’s useful life; the IRS opined that the IP had an indefinite useful life, whereas Amazon applied a useful life of seven years.  The DCF methodology determines a value for an asset today, by discounting forecasted future earnings over its useful life.  Therefore, extending the assets’ useful life also extends its earnings, and in turn, its value.

For the annual contributions to maintain the IP, Amazon used a multistep system to allocate costs from the cost centers to IDCs.  While generally accepting Amazon’s allocation method, a contentious point in the IRS’s argument was that 100 percent of the costs captured in a cost center named Technology and Content should be allocated to IDCs.  The result of this determination was to increase the Subsidiary’s cost sharing payments by $23.0 million and $109.9 million in 2005 and 2006, respectively. 

The total adjustment resulted in an estimated $1.5 billion tax bill, plus interest, for transactions in 2005 and 2006.
Amazon Stance For the buy-in payment, Amazon contended that each group of transferred assets—the website technology, the marketing intangibles, and the European customer information—must be valued separately, and chose a transfer pricing method called comparable uncontrolled transaction (“CUT”) method to value the IP.[5] In the original cost sharing arrangement, a third-party accounting firm determined that the appropriate buy-in price was $254.5 million, to be paid over a seven-year period commencing in 2005.  An essential argument for Amazon was that the transferred intangibles had a limited useful life of seven years, which was amortized over time.  Amazon argued that the software supporting the European operations website was in a fragile state when it first established the Subsidiary, and therefore could support a finite useful life. 
Decision The court held on four points:
  • First, the IRS’s determination with respect to the buy-in payment was arbitrary, capricious, and unreasonable;
  • Second, Amazon’s CUT method, with appropriate upward adjustments in numerous respects, was the best method to determine the requisite buy-in payment;
  • Third, the IRS abused its discretion in determining that 100 percent of Technology and Content costs constituted IDCs; and
  • Fourth, Amazon’s original cost-allocation method, with certain adjustments, supplied a reasonable basis for allocating costs to the IDCs.
The court considered Amazon's expert witnesses' useful life estimates of between eight years and 20 years and concluded that the marketing intangibles did not have a perpetual useful life, but rather a life of 20 years.  In addition, the court agreed with Amazon that the IRS’s determination that all Technology and Content costs should be allocated was arbitrary and capricious, and that only about half of the costs should be allocated to IDCs.

The court's opinion rests primarily on the conclusion that the Subsidiary “assumed sole responsibility to maintain and develop the marketing intangibles,” and that it contributed to the technology improvements needed to maintain the IP’s value.  The decision was also based on Amazon's assertions that the Internet retail industry had yet to mature and that Amazon's success depended on technological assets subject to frequent market disruptions.
BDO Insights Amazon successfully contended that the IRS’s DCF methodology was substantially similar to that applied in Veritas Software Corp. v. Commissioner, where the Tax Court had already held that the specific application of the DCF was arbitrary and capricious.  The Amazon case was widely regarded as an opportunity for the IRS to reverse its position and set a precedent for future transfer pricing disputes.  The court agreed with Amazon and cited Veritas as a precedent for its ruling on the buy-in payment.  The Amazon case could end up costing the IRS billions of dollars if the ruling inspires other companies to contest similar issues.  However, the Amazon ruling was based on the application of the regulations in effect in 2005 and 2006.  The IRS issued new cost sharing regulations on December 16, 2011, after issuing temporary and proposed regulations on December 31, 2008.  While the court ruled in favor of the taxpayer on the aforementioned points in Amazon., future cost sharing litigation may be subject to different rules, depending on the tax years in question.

References
  1. “Tax Court Holds for Amazon in Transfer Pricing Case,” BNA, March 23, Dolores Gregory and Sony Kassam.
  2. “Amazon wins multimillion dollar transfer pricing dispute with IRS,” Journal of Accountancy, March 23, Alistair Nevius.
  3. “Amazon Just Won a $1.5 Billion Tax Fight,” Fortune.com, March 23, Reuters.
  4. Amazon v. Comm’r¸148 T.C. 8 (2017).
  5. Veritas Software Corp. v. Comm’r, 133 T.C. 297 (2009).
 
For more information, please contact one of the following practice leaders:    Mark Schuette
Partner   Kirk Hesser
Managing Director   Veena Parrikar
Principal   Sean Kim
Managing Director   Michiko Hamada
Managing Director   Noyan Tulmen
Managing Director     [1] Amazon.com Inc. is referred to as “Amazon” or “Petitioner,” and the Commissioner of Internal Revenue is referred to as “IRS” or “Respondent.” [2] The legal name for the Subsidiary is Amazon Europe Holding Technologies SCS. [3] Petitioner tracked expenses in six high-level cost centers: (1) Cost of Sales, (2) Fulfillment, (3) Marketing, (4) Technology and Content, (5) General and Administrative (G&A), and (6) Other. [4] The IRS valuation was later reduced to $3.5 billion. [5] In accordance with Treasury Regulation section 1.482-4

Federal Tax Alert - May 2017

Fri, 05/12/2017 - 12:00am
House Approves Affordable Care Act Repeal and Replacement Bill The House voted along party lines on May 4 to approve a repeal and replacement plan for the Affordable Care Act (ACA). The American Health Care Act (AHCA) (H.R. 1628), approved by a 217 to 213 margin, would eliminate most of the ACA's taxes, including the penalties connected with the individual and employer mandates. The House bill now moves to the Senate where changes are expected; indeed, the Senate may craft its own ACA repeal and replacement bill. 

The following tax briefing covers this decision in detail and discusses the impact.
  Download

State and Local Tax Alert - May 2017

Wed, 05/10/2017 - 12:00am
Tennessee Enacts the "IMPROVE Act," Including Single Sales Factor Apportionment Election for Manufacturers and Other Tax Changes Summary On April 27, 2017, Tennessee enacted H.B. 534, the “Improving Manufacturing, Public Roads and Opportunities for a Vibrant Economy Act,” known as the “IMPROVE Act.”  Although the bulk of the legislation addresses fuels taxes and provides funding for 962 road and other highway infrastructure projects in all of Tennessee’s 95 counties, the IMPROVE Act also provides a single sales factor apportionment election for taxpayers engaged in manufacturing in Tennessee.  In addition, among other changes, the IMPROVE Act reduces the sales tax on food (from five percent to 4.5 percent) and accelerates the phase-out of the Tennessee “Hall income tax.” 
  Details Single Sales Factor Apportionment Election for Manufacturers
 
During Tennessee’s 2015 Legislative session and as part of the Revenue Modernization Act (“RMA”), the general apportionment formula for franchise and excise tax purposes was amended to triple-weight the sales factor for all taxpayers not subject to special apportionment formulas (such as financial institutions and transportation companies).  Now with H.B. 534, taxpayers whose “principal business in Tennessee is manufacturing” are allowed to elect to apportion their net earnings (for excise tax purposes) and net worth (for franchise tax purposes) using a single sales factor formula.  The election is effective for taxable years beginning on or after January 1, 2017.
 
A taxpayer whose principal business in Tennessee is manufacturing qualifies to make the election if more than 50 percent of its revenue derived from activities in Tennessee is fabricating or processing tangible personal property for resale and consumption off the premises.  The election is made on the Tennessee franchise and excise tax return (Form FAE 170), and is binding for a period of five taxable years.  The election renews automatically unless the taxpayer revokes the election in writing on its FAE 170 filed for the taxable year that the revocation is to be effective.  If the election is revoked, the taxpayer cannot re-elect the single sales factor apportionment formula for a period of five taxable years.   
 
Other Tennessee Tax Changes
 
The IMPROVE Act also adopts the following Tennessee tax changes:
 
  • Motor fuel tax rates are increased effective July 1, 2017.  In addition, counties with populations over 112,000 and cities with populations over 165,000 (currently Chattanooga, Knoxville, Memphis, and Nashville) are authorized to impose a tax surcharge on local option sales tax, business tax, hotel occupancy tax, and certain other local taxes at the time a transit improvement plan is adopted. 
  • Effective July 1, 2017, the sales tax on food is reduced from 5 percent to 4.5 percent.
  • The IMPROVE Act accelerates the phase-out of Tennessee’s “Hall income tax” (an income tax on interest and dividend income).  The RMA enacted in 2015 stated an intent to phase-out the Hall income tax; the IMPROVE Act places the phase-out into effect.  For 2017, the Hall income tax rate will be reduced to four percent, to three percent for 2018, to two percent for 2019, to one percent for 2020, and completely phased out for the 2021 taxable year.
  BDO Insights
  • With the single sales factor election for Tennessee manufacturers, the state becomes the latest of the now-majority of states that require or provide an election to use the single sales factor apportionment formula. 
  • Taxpayers affected by Tennessee’s provision of a single sales factor apportionment formula election for manufacturers should consult with their financial statement auditor and tax advisor to evaluate and determine the potential financial statement implications under ASC 740, including the impact on current and deferred taxes, uncertain tax benefits, and disclosures.
   

For more information, please contact one of the following regional practice leaders:
 

West:   Atlantic: Rocky Cummings
Tax Partner
    Jeremy Migliara
Tax Managing Director
  Paul McGovern
Tax Managing Director   Jonathan Liss
Tax Managing Director   Northeast:   Central: Janet Bernier 
Tax Partner
    Angela Acosta
Tax Managing Director
  Matthew Dyment
Tax Principal
    Nick Boegel
Tax Managing Director
 
Southeast:   Joe Carr
Tax Principal
  Ashley Morris
Tax Managing Director
    Mariano Sori
Tax Partner
  Scott Smith
Tax Managing Director
    Richard Spengler
Tax Managing Director
  Tony Manners
Tax Managing Director






   
Southwest:
Gene Heatly
Tax Managing Director

Tom Smith
Tax Partner
 

Federal Tax Alert - May 2017

Wed, 05/03/2017 - 12:00am
Tax Court Decision Addresses Self-Employment Taxes of LLC Members Download PDF Version
Summary In Vincent J. Castigliola, et ux., et al. v. Commissioner, TC Memo 2017-62, the Tax Court held that the three members of a Mississippi Professional Limited Liability Company (“PLLC”) in the practice of law were subject to self-employment tax on their entire distributive share of the PLLC’s income, despite the fact that they received guaranteed payments commensurate with local legal salaries.  The case builds on existing judicial authority in an area where statutory and regulatory guidance is lacking.
Background During the years in question, the three taxpayers were attorneys licensed to practice law in the State of Mississippi.  On July 12, 2001, they reorganized their law firm as a professional limited liability company—Bryan, Nelson, Schroeder, Castigliola & Banahan, PLLC.  They were each engaged in the practice of law solely through their PLLC.  The members' compensation agreement required guaranteed payments to each member that were commensurate with local legal salaries, as determined by a survey of legal salaries in the area.  Any net profits of the PLLC in excess of amounts paid out as guaranteed payments were distributed among the members in accordance with the members’ agreement.

Section 1401(a) imposes a tax on the self-employment income of individuals (self-employment tax).  The base for self-employment tax is generally "net earnings from self-employment” (“NESE”) as defined by section 1402 and includes a taxpayer’s “distributive share (whether or not distributed) of income or loss described in section 702(a)(8) from any trade or business carried on by a partnership of which he is a member.”  Section 1402(a)(13) provides an exclusion from self-employment income for “the distributive share of any item of income or loss of a limited partner, as such, other than guaranteed payments described in section 707(c) to that partner for services actually rendered to or on behalf of the partnership to the extent that those payments are established to be in the nature of remuneration for those services.”

The taxpayers in Castigliola did not dispute that their guaranteed payments were subject to self-employment tax, but contended that their distributive share of PLLC income in excess of those guaranteed payments should be excluded from NESE under section 1402(a)(13).  The IRS argued that the taxpayers were not limited partners within the meaning of section 1402(a)(13), so that the exclusion did not apply.  Accordingly, the question addressed by the Court was whether the taxpayers were limited partners within the meaning of the statute.

Citing Renkemeyer, Campbell, & Weaver, LLP v. Commissioner, 136 T.C. 137 (2011) (“Renkemeyer”), the Court noted that no statutory or regulatory authority defines the term "limited partner" for purposes of section 1402(a)(13), and that as a result, it is necessary to apply accepted principles of statutory construction to ascertain congressional intent, giving the term its ordinary meaning at the time of enactment.  Therefore, in Castigliola, the Court reviewed the history of the Revised Uniform Limited Partnership Act (“RULPA”) and its application by various States, and concluded that the primary characteristics of a limited partner common to each State are limited liability and lack of control of the business.  The taxpayers in this case were each found to have participated in control of the business of their PLLC: they all participated in collectively making decisions regarding their distributive shares, borrowing money, hiring, firing, and rate of pay for employees.  They each supervised associate attorneys and signed checks for the PLLC.  As such, the Court concluded that the taxpayers could not have qualified as limited partners under any version of the RULPA and were not limited partners under section 1402(a)(13).
Comments Castigliola closely follows the Tax Court’s earlier decision in Renkemeyer in concluding that the meaning of the term “limited partner” for purposes of section 1402(a)(13) must be determined based on Congressional intent, and not, for example, by state law designations.  Thus, it is conceivable that a taxpayer who is a limited partner under state law may not be a limited partner for purposes of section 1402(a)(13), although no court has yet addressed that fact pattern.  The Castigliola court’s reliance on the RULPA in determining the characteristics of a limited partner imply that the circumstances under which a state-law limited partner would not qualify for the 1402(a)(13) exclusion may be very narrow.

Both decisions are largely consistent with Prop. Reg. section 1.1402(a)-2, which provides generally that for this purpose, an individual member of an organization classified as a partnership for federal tax purposes is treated as a limited partner unless he (i) has personal liability for the debts of or claims against the partnership by reason of being a partner; (ii) has authority (under the law of the jurisdiction in which the partnership is formed) to contract on behalf of the partnership; or (iii) participates in the partnership's trade or business for more than 500 hours during the partnership's taxable year.  The proposed regulations were issued in 1997 and the timeline for their finalization remains uncertain.  However, the IRS has stated informally that taxpayers may rely on them.
BDO Insights Members of entities classified as partnerships and their tax advisors should consider Castigliola and the other authorities cited in this alert in determining whether their distributive share of the entity’s trade or business income can be excluded from NESE under section 1402(a)(13).   Particularly when a member is not specifically designated as a limited partner under State law, such member should determine whether he or she would be treated as a limited partner under Prop. Reg. section 1.1402(a)-2, and alternatively whether he or she meets the Congressional intent test applied by the Tax Court in Renekemeyer and Castigliola.  A corresponding analysis should be performed by entities in preparing Schedules K-1 for their individual members.  The analysis should take into account the member’s liability for entity level debts by reason of being a member (as opposed to liability as a guarantor, for example), the member’s authority to control the entity’s business, and the nature and extent of any services he or she provides.
 
If you have questions regarding this alert or need assistance in determining whether a partner’s income is subject to self-employment tax, please contact a member of the National Tax Office Partnership Group. 
  David Patch
Tax Managing Director   Jeff Bilsky
Tax Partner    Julie Robins
Tax Managing Director   Will Hodges
Tax Manager   Katie Pendzich
Tax Senior Manager    

BDO Transfer Pricing News - April 2017

Sun, 04/30/2017 - 12:00am
Transfer pricing is increasingly influencing significant changes in tax legislation around the world. This 23rd issue of BDO’s Transfer Pricing Newsletter focuses on recent developments in the field of transfer pricing in Australia, Germany, India, Ireland, Malaysia, Puerto Rico and Spain. 

  View the Newsletter

Expatriate Tax Newsletter - April 2017

Sun, 04/30/2017 - 12:00am
BDO's Expatriate Newsletter covers timely tax-related updates and regulations from countries around the globe. The April 2017 issue highlights developments in Canada, Germany, Ireland, The Netherlands, Singapore, Switzerland, and the United Kingdom.

Topics include:
  • Germany: Social Security for workers in the United Kingdom
  • Singapore: Singapore and Ghana sign Double Tax Treaty
  • United Kingdom: New notification requirements for Country-by-Country Reporting
  Download

Federal Tax Alert - April 2017

Fri, 04/28/2017 - 12:00am
IRS Introduces Three New Automatic Method Changes and Provides Modified Procedures Download PDF Version
Summary On April 19, 2017, the Internal Revenue Service issued Revenue Procedure 2017-30 to update the list of automatic changes in methods of accounting to which the automatic change procedures under Rev. Proc. 2015-13 applies.  In addition to adding three new automatic accounting method changes, the Rev. Proc. modifies existing automatic method changes, removes certain obsolete method changes, and provides limited transition rules. 
 
For federal income tax purposes, once a taxpayer has adopted or established a method of accounting, that method, whether proper or improper, must continue to be used until the taxpayer files a Form 3115, Application for Change in Accounting Method, to secure the Service’s consent to change to a different method.  Taxpayers should carefully review the more than two hundred automatic method changes listed in Rev. Proc. 2017-30 to identify any opportunities to file automatic method change request to secure the Service’s consent to change to the proper or most optimal method of accounting in order to address any exposures, reduce taxable income and increase cash tax savings. 
 
Rev. Proc. 2017-30 generally supersedes Rev. Proc. 2016-29 and is effective for automatic accounting method change requests filed on or after April 19, 2017, for a taxable year of change ending on or after August 31, 2016.  In light of the immediate effective date of this revenue procedure, all Form 3115 requests filed under the automatic procedures set forth in Rev. Proc. 2015-13 must now be filed pursuant to this new procedure.  
  New Automatic Method Changes  Rev. Proc. 2017-30 contains a list of over two hundred automatic method changes.  In general, if the method change is identified as automatic by the Service, the Form 3115 request is subject to lower IRS scrutiny (i.e., the taxpayer is deemed to have “automatic consent” to change to the new method of accounting), no user fee, and an extended deadline for filing the request.  If a method change is not identified as automatic by the Service or the taxpayer did not meet an eligibility requirement under Rev. Proc. 2015-13, the taxpayer is required to file a non-automatic Form 3115.  A non-automatic change is subject to greater IRS scrutiny, requires an IRS user fee, and must be filed no later than the last day of the year of change.  A favorable development in Rev. Proc. 2017-30 is the addition of the following three new automatic method change procedures:
 
  • Organizational expenditures under Section 248 (Automatic Change #228): This new automatic procedure applies to a change in the characterization of an item as an organizational expenditure; the determination of the taxable year in which the corporation begins business to which the organizational expenditures relate; or the amortization of an organization expenditure to 180 months.
 
  • Organization fees under Section 709 (Automatic Change #229): This new automatic procedure applies to a partnership that wants to change the characterization of an item as an organization expense; the determination of the taxable year in which the partnership begins business to which the organizational expenses relate; or the amortization period of an organizational expense to 180 months.
 
  • Change from currently deducting inventories to permissible methods of identification and valuation of inventories (Automatic Change #230): This new automatic procedure applies to a taxpayer changing from currently deducting inventories to a permissible method of identifying and valuing inventories. For example, a taxpayer currently deducting inventories may change to using the first-in, first-out (FIFO) method as its inventory-identification method and cost or market, whichever is lower (LCM), as its inventory-valuation method.
  Modifications to Existing Method Changes  Rev. Proc. 2017-30 sets forth certain significant changes, among others, to existing automatic method changes.  Several of the method changes that were previously automatic, including the change to make a late partial disposition election and the revocation of a taxpayer’s general asset account election, were removed in their entirety from the list, as they are now obsolete. Additionally, the Service removed temporary waivers of certain eligibility rules applicable to specific method changes for which the waivers expired in previous years.
 
Aside from the removal of several method changes and eligibility rule waivers, Rev. Proc. 2017-30 also revises certain terms and conditions of numerous automatic method changes remaining on the list.  Some of the key modifications set forth under Rev. Proc. 2017-30 include the following:
 
  • Start-up expenditures (Automatic Change #223): The new revenue procedure now includes a change in the amortization period of a start-up expenditure to 180 months.
 
  • Deducting repair and maintenance costs (Automatic Change #184): The new revenue procedure specifies that the automatic change procedures do not apply to amounts paid or incurred for repair and maintenance costs that the taxpayer is changing from capitalizing to deducting and for which the taxpayer has received a payment for specified energy property in lieu of tax credits under Section 1603.
 
  • Section 467 rent (Automatic Change #136): Previously, rental agreements providing a specific allocation of fixed rent as described in Reg. Section 1.467-1(c)(2)(ii)(A)(2) were excluded from the automatic change procedures.  The new revenue procedure modifies the language to clarify that the automatic provisions do not apply to rental agreements that provide a specific allocation of fixed rent that allocate rent to periods other than when such rents are payable.
 
  • Mark-to-market accounting (Automatic Change #64): Rev. Proc. 2017-30 modifies the existing automatic method change to provide that the eligibility rule in Section 5.01(1)(d) of Rev. Proc. 2015-13 (generally precluding a taxpayer from filing an automatic method change in the final year of its trade or business) does not apply to this change.
 
There are numerous modifications in Rev. Proc. 2017-30 that are not addressed above.  Therefore, it is prudent to review the relevant section(s) of the revenue procedure pertaining to the method change(s) at issue to ensure that the taxpayer is able to make the method change under the automatic change procedures.
  Effective Date and Limited Transition Relief Rev. Proc. 2017-30 is effective for automatic accounting method change requests filed on or after April 19, 2017, for a taxable year of change ending on or after August 31, 2016. 
 
Rev. Proc. 2017-30 provides transition rules for Form 3115 requests that were previously filed under the nonautomatic method change procedures where the applicable method change is now an automatic method change.  If the nonautomatic Form 3115 was filed prior to April 19, 2017, under Rev. Proc. 2015-13 and remains pending with the IRS National Office as of that date, the taxpayer may notify the Service to convert the application into an automatic change.
 
In addition, Rev. Proc. 2017-30 eliminated certain automatic method changes previously available under the now-superseded Rev. Proc. 2016-29.  By default, such method changes must now be filed under the nonautomatic change procedures of Rev. Proc. 2015-13.  If the taxpayer properly filed the original or the duplicate copy of a Form 3115 under the prior automatic change procedures before April 19, 2017, that method change remains automatic.  However, if the taxpayer did not properly file the original or the duplicate copy of such Form 3115, that method change must be filed nonautomatically. 
  BDO Insights  Rev. Proc. 2017-30 reflects the Service’s continued efforts to expand the list of automatic changes available to taxpayers.  As these changes generally are easier to implement in comparison to those filed under the nonautomatic change procedures, the recent additions to the list of automatic changes represents a welcome relief from many of the administration burdens associated with making a change in method of accounting.  Further, the Service has indicated informally that it intends to revisit the list of automatic changes on a regular basis, and is open to feedback from taxpayers and practitioners as to whether any method changes that are presently nonautomatic - particularly those that are fairly straightforward and uncontroversial from a tax accounting perspective - should be added to the list of automatic changes.  For those that might have suggestions for method changes to add, BDO’s NTO Accounting Methods group routinely liaises with the IRS and can assist with communicating the feedback to the IRS.  Please contact any member of the NTO Accounting Methods group to discuss further.
 
For more information, please contact one of the following practice leaders: 
  Travis Butler    Yuan Chou   Connie Cunningham   Dave Hammond   Marla Miller    

Federal Tax Alert - April 2017

Thu, 04/27/2017 - 12:00am
Trump Administration Announces President's Outline for Tax Reform 

Download PDF Version

Summary On April 26, 2017, Treasury Secretary Steven Mnuchin and National Economic Council Director Gary Cohn announced President Donald Trump’s outline for individual and business tax reform, which includes new federal income tax rates and repeal of the estate tax.
Details On April 26, 2017, during a White House daily press briefing, Treasury Secretary Steven Mnuchin and National Economic Council Director Gary Cohn announced President Donald Trump’s outline for individual and business tax reform.

Describing a broad framework for individual tax reform, Director Cohn discussed the Administration’s proposal to reduce the current seven individual tax brackets (currently 10, 15, 25, 28, 33, 35, and 39.6 percent) down to three brackets at rates of 10, 25, and 35 percent.  The standard deduction would be doubled to approximately $24,000 for those married taxpayers filing joint returns.  Relief for child and dependent care costs would also be included.

The top rate for capital gains would be 20 percent, and the 3.8 percent net investment income tax that applies to income above a certain level would be repealed.  Most tax deductions would be eliminated, except for those related to mortgage interest, charitable contributions, and retirement.  The President’s plan would also repeal the estate tax and individual alternative minimum tax.

Secretary Mnuchin described the proposed business tax reform provisions, which would include a reduction of the corporate or “business” tax rate from 35 percent to 15 percent for businesses of all sizes.  In addition, the United States would move from its worldwide tax system to a territorial tax system, which would tax U.S. businesses only on what they earn within the United States rather than on profits earned around the world. Finally, the Administration would include a one-time tax (rate unspecified) on overseas profits, which the Treasury Secretary indicated would return money back to the United States for investment by U.S. businesses.

No detail or proposed legislative language was provided during the Administration’s announcement.  A white paper was distributed to the press noting these items.
  BDO Insights
  • No detailed description of the legislative proposal or proposed legislative language was provided during the Administration’s announcement, which leaves open many questions regarding the application and scope of the President’s reform proposals.  For example, it is unclear from the proposal what would be the one-time overseas profits tax rate.  Moreover, the proposal does not clarify how the 15-percent business rate would apply to income from pass through entities.  The proposal also does not indicate whether the 20-percent capital gains rate would also apply to qualified dividends.
  • Some of the concepts announced by the Administration have both bipartisan and bicameral support, such as some reduction in the corporate tax rate.  For example, former House Ways & Means Chairman Camp (R-MI) and former Senate Finance Chairman Ron Wyden (D-OR) in recent years each proposed a corporate rate cut.
  • The House Republican leadership released its tax reform “Blueprint” in June 2016, which contains a host of tax reform proposals with some more detail, which is an indication of what a future House tax reform proposal package may look like.
  • The Administration’s proposal does not include many of the provisions in the House Blueprint, such as a border adjustment tax, which would tax imports and exempt exports, the deduction of interest expense against interest income with excess interest expense carryforward, or a current deduction for the cost of certain tangible and intangible assets.
  • The Administration’s proposal is one of many steps in the process of possible future tax reform legislation.  In the near future, we can expect the House and Senate to each consider their own tax reform packages, which may lead to a tax reform package that the House, Senate, and President must each agree to.
  • Under current Senate rules, 60 votes generally are needed to pass any tax cuts that would add deficits beyond 10 years.  A bill could be passed with 51 votes, but only if it does not add deficits beyond the 10-year budget window, which would essentially require that any tax cut package expire after 10 years, similar to the Economic Growth and Tax Relief Reconciliation Act of 2001.
 
For more information on matters discussed above, please contact:
  Todd Simmens
National Managing Partner of Tax Risk Management   Joe Calianno
Partner and International Tax Technical Practice Leader    Kevin Anderson
Partner, National Tax Office   Doug Bekker
Tax Partner

Trump, Legislation and Tax – How will tax reform impact international businesses?

Wed, 04/26/2017 - 12:00am
By Joe Calianno, Todd Simmens, Scott Smith

While President Trump has formally announced his intentions for simplifying the tax code, specific policy details remain unclear. Now more than ever, U.S. federal tax reform is top-of-mind for businesses across the globe. On March 28, we hosted a webinar with BDO UK to review the tax reform changes proposed by both the Congressional GOP’s “Blueprint” plan and the president, and discuss the potential ramifications for international businesses. You can view the full webinar, hosted by BDO UK’s Malcom Joy and featuring BDO USA’s Todd Simmens, Joe Calianno and Scott Smith, below.
 

 
During the webinar, we polled the participants on what they think is on the horizon for U.S. tax policy. Take a look at their responses below.



While the majority (59%) of our international audience believe that tax reform is likely under President Trump, this is an interesting contrast from our annual survey of U.S. tax executives, in which 100% of respondents said they think tax reform will occur.



In light of the failure to secure the votes necessary to pass legislation to repeal the Affordable Care Act, concern has grown that the Trump administration and GOP members in Congress have burned a significant amount of political capital that may impair their ability to move forward with other legislative priorities. Our poll, taken just 4 days after the repeal failed, found that 40 percent of participants said the fate of Trumpcare influenced their feelings on the likelihood of tax reform legislation passing. 


 
Chief among President Trump’s tax reform promises is slashing the federal tax rate for U.S. businesses from 35 percent to 15 percent, but now multiple outlets say this plan is being abandoned in favor of one that could gain greater congressional, and potentially bipartisan, support. Our poll found that while the majority believe the corporate tax rate will come down, most believe it will settle around the 20-24 percent mark when all is said and done.



The final poll question addressed opinions on territorial tax. Based on the GOP House Blueprint (and certain earlier tax reform proposals), there is a strong likelihood that the United States may move from a worldwide tax system to a territorial tax system where dividends from foreign subsidiaries generally would be exempt from U.S. tax. Our polling audience agreed with this potential change as well.

Learn more about tax executives’ 2017 outlook in our Tax Outlook Survey.
 
For more information please contact:
  Joe Calianno
Partner and International Technical Tax Practice Leader   Todd Simmens
National Managing Partner, Tax Risk Management   Scott Smith
Technical Practice Leader, State and Local Tax    

R&D Tax Credit FAQs - Small Businesses - Path to Payroll Tax Credit

Wed, 04/26/2017 - 12:00am


BDO has received a lot of questions related to the federal R&D tax credit and how it can benefit startups and small companies in particular. New legislation has greatly expanded these companies’ potential R&D benefit, enabling them to offset, annually, up to $250,000 of their payroll taxes using R&D credits, up to $1,250,000 over a five-year period.

Common questions and answers are outlined below. If you have a question that isn’t addressed, please let us know at RDTaxCredit@BDO.com.

 
What activities qualify?
In general, activities qualify if they meet each element of a “four-part test” and aren’t excluded.
Four-part Test
  1. Qualified purpose. The purpose of the activity is to improve the functionality, performance, reliability, or quality of a product, process, software, technique, invention or formula (“component”) that is intended to be used in the taxpayer’s business or held for sale, lease or license.
  2. Technological uncertainty. The taxpayer encounters uncertainty regarding whether it can or how it should develop the component, or regarding the component’s appropriate design.
  3. Process of experimentation. To eliminate the uncertainty, the activities include evaluating alternatives through modeling, simulation, systematic trial and error, or other methods.
  4. Technological in nature. The success or failure of the evaluative process is determined by the principles of engineering, physics, chemistry, biology, computer science, or similar natural or “hard” science, as opposed to principles of, e.g., economics, consumer preferences.

Exclusions Some activities are excluded because they aren’t likely to incentivize increased R&D in the U.S., e.g., activities:
 
  • Conducted outside the U.S.
  • Relying on the social sciences, arts or humanities, as opposed to, e.g., engineering or the physical, biological, or computer sciences.
  • To collect routine data or ordinary testing for quality control of existing components.
  • Market research; management, consumer preference testing.
  • “Funded” by an unrelated third party, i.e., for which the taxpayer doesn’t either retain rights to the results of the activity or necessarily have to pay for the activity because an unrelated third party is contractually obligated to pay for it, even if the activity fails to produce the desired result.
  • To develop or improve software originally intended primarily for the taxpayer’s use. Exceptions exist for this exclusion, and taxpayers have claimed and supported on exam hundreds of millions of dollars related to internal-use software development. 

Back to top
 
What expenses qualify?
  1. Taxable wages for employees who perform or directly supervise or support qualified activities.
  2. Cost of supplies used in qualified activities, including extraordinary utilities, excluding capital items or general administrative supplies. 
  3. 65%-100% of contract research expenses for qualified activities, provided the taxpayer retain substantial rights to the activity’s results and must pay the contractor whether it succeeds or fails.
  4. Rental or lease costs of computers used in qualified activities, e.g., payments to cloud service providers (CSPs) for the cost of renting server space to develop or improve a component. 

Back to top
 
What companies can benefit?  In general, any company—in any industry and of any size—that invests in activities of the kind outlined above can benefit if it paid, pays or expects to pay:
 
  1. Regular federal income tax;
  2. A similar state tax in one of the more than 40 U.S. states that provide for incentives for R&D and R&D-related investments; or
  3. Similar taxes in one of the more than 35 non-U.S. countries that, too, provide for such incentives. 

Companies can benefit, too, even if they’re not paying such taxes now:
 
  1. The federal credit can be carried back one year and forward 20. Most states provide similar and sometimes indefinite carryforward periods.
  2. Startups and smaller companies may use R&D credits against:
    • Up to $250,000 of their payroll taxes each year, provided they have:
      • Gross receipts less than $5 million in the taxable credit year;
      • No gross receipts for any taxable year preceding the 5-taxable year period ending with the taxable credit year; and
      • R&D credits that they can use in that year; or
    • Alternative Minimum Tax (AMT), provided they:
      • Are privately held;
      • Owe AMT in the current year; and
      • Have $50 million or less in average gross receipts for the preceding three tax years.
  3. Many states also allow companies to sell or transfer their credits to other taxpayers.
  4. Several states’ credits are refundable, i.e., they are paid to taxpayers even if the taxpayers aren’t currently paying taxes. 

Back to top
 
Does a company have to be a “startup” or “small business” to be eligible for the payroll offset?  No. It just has to have:
 
  1. Gross receipts less than $5 million in the taxable credit year;
  2. No gross receipts for any taxable year preceding the 5-taxable year period ending with the taxable credit year; and
  3. R&D credits it can use in that year. 

So even companies that have been around for more than five years and have spent billions of dollars to try to develop or improve a component could be eligible; e.g., a significant percentage of life science companies with $0 gross receipts for long periods of time before their drug receives U.S. Food and Drug Administration approval.
 
Back to top
 
Can companies formed more than five years ago benefit for the payroll offset?  Yes. For the 2016 payroll offset, a company isn’t eligible if it generated gross receipts prior to 2012, because then it would have gross receipts in a taxable year preceding the 5-taxable year period ending with the taxable credit year, 2016. But a company formed prior to 2012 that didn’t receive gross receipts could qualify.
 
Although the law is intended to benefit small businesses, large businesses could also potentially benefit. For example, a significant percentage of life science companies have $0 gross receipts for long periods of time before their drug receives US Food and Drug Administration approval.
 
Back to top
 
Are companies that use professional employer organizations (PEOs) eligible for the payroll offset?  Yes.

Back to top
 
When do I claim the payroll tax offset?  The payroll tax offset is available on a quarterly basis beginning in the first calendar quarter that begins after a taxpayer files their federal income tax return.
 
For example, companies need to file their 2016 federal income tax returns by March 30, 2017, to apply the payroll tax offset to the second quarter. As a result, the earliest taxpayers are likely to see a benefit is July 2017, when they file their quarterly payroll tax returns for the second quarter (Form 941).
 
If you extend your return, you’ll be able to take advantage of the offset in the quarter after you file your federal return: file the return by June 30, 2017; take offset on the October 31, 2017 Form 941 filing; file return by September 30, 2017; and take offset on January 31 Form 941 filing.
 
Back to top
 
How do I claim the payroll offset? 
  1. Identify and gather support for the credit to which you’re legally entitled.
  2. Report the credit on a timely-filed 2016 federal tax return and elect the payroll offset.If you filed a 2016 return reporting the R&D credit but not electing the payroll tax credit, you may make the election on an amended return filed on or before December 31, 2017. To qualify for this extension, your business must either (a) indicate on the top of your Form 6765 showing the payroll tax credit election that the form is “FILED PURSUANT TO NOTICE 2017-23” or (b) attach a statement to your Form 6765 showing the payroll tax credit election that the form is filed pursuant to Notice 2017-23.
  3. Claim no more than $250,000 of the credit on your quarterly Form 941. 

If you didn’t claim the credit in 2016, you can still take advantage of the payroll offset for tax years 2017, 2018, 2019 and 2020. If you couldn’t have used the credit in 2016, you may identify it and carry it back to 2015. If it could not have been used in 2015, you may carry it forward to 2017 or a future year in which you could use it, up to 20 years from the year in which the credit was generated.

Back to top
 
What does $5 million in “gross receipts” mean for the payroll offset?
There are three things to consider regarding gross receipts.
 
  1. Businesses related or under common control must aggregate their gross receipts.
  2. Gross receipts for any taxable year of less than 12 months must be annualized by multiplying the gross receipts for the short period by 12 and dividing the result by the number of months in the short period.
  3. What should be included as “gross receipts”?
    • Current guidance from the IRS defines gross receipts for purposes of this provision as total sales (net of returns and allowances) and all amounts received for services. In addition, gross receipts include any income from investments, and from incidental or outside sources. As currently defined, a company that reported interest only on its tax return prior to 2012 would be precluded from taking the payroll tax offset. 
    • The IRS has received several comment letters regarding this definition, which precludes several businesses from qualifying, even though the payroll offset was enacted primarily to benefit such companies. We are waiting on additional guidance from the IRS to see if this definition will be modified.

Back to top
 
What if a company can’t use the payroll offset this quarter?  If a company can’t use the credit to offset its payroll taxes this quarter, it may carry the credit forward to subsequent quarters in which it can use it, provided the $250,000 annual cap isn’t exceeded. Amounts over $250,000 can be carried forward for 20 years to offset future regular tax liability on the company’s tax return.
 
Back to top
 
What if a company has a short taxable year in 2016 or other relevant year?  For businesses with a short taxable year in 2016—e.g., businesses that started up in 2016—gross receipts must be annualized. This is true for all short taxable years that affect the determination of whether a company is eligible for the payroll offset. For more on the definition of “gross receipts,” please see this section.
 
Back to top
 
Examples of the benefit
Example 1. A company incurs $300,000 in eligible costs in an attempt to develop its flagship software product. The company was founded in 2012 and has generated no gross receipts to date. Eligible expenses generate a credit of approximately $30,000. Because the company meets the criteria, it can use $30,000 of credits to offset its FICA payroll tax on its quarterly Form 941 filings. 

Example 2. A company incurs $2,500,000 in eligible costs related to developing a new medical device. The company was founded in 2008 and has generated no gross receipts, not even interest income, prior to 2014. For 2016 they generated $4,000,000 in gross receipts. Eligible expenses generate a credit of approximately $250,000. Because the company meets the criteria, it can use $250,000 in credits to offset its FICA payroll tax on its quarterly Form 941 filings. 

Example 3. A company incurs $6,000,000 in eligible costs related to developing and improving its new line of consumer products. The company was founded in 2013 and has generated $500,000 in gross receipts each year to date. Eligible expenses generate a credit of approximately $600,000. Because the company meets the criteria, it can use $250,000 of these credits to offset FICA payroll tax on its quarterly Form 941 filings. The remaining $350,000 in credits will carryforward for 20 years to offset future regular tax liability on the company’s tax return. 

In each example, should the companies continue to meet the payroll offset criteria in future tax years, they can use up to $250,000 in credits each year for the next 5 years to offset their FICA payroll taxes, for a potential of $1,250,000 in cash savings.
 
Back to top
 
What FICA taxes can be offset by the R&D credit?  Up to $250,000 of the employer’s Social Security portion (OASDI) of payroll taxes can be offset by R&D credits.
 
Companies are required to pay Social Security tax of 6.2 percent on up to $118,500 of each employee’s salary in 2016. A company that employs 50 employees with an average salary of $95,000 per person would pay approximately $294,500 in Social Security payroll taxes in 2016. As such, a company would need to have more than $4 million in annual payroll subject to Social Security tax and $2.5 million in eligible R&D costs to offset the maximum $250,000 in payroll taxes each year under the new law.
 
Most employers are required to deposit their payroll taxes to the federal government on a monthly or semiweekly basis and file a quarterly payroll tax return (Form 941). The credit is applied against the Social Security tax on the quarterly return, or against amounts when the tax is deposited monthly or semiweekly.
 
Back to top
 
What are the risks of claiming the R&D credit? 
  1. IRS exam. Like any other tax position, it is possible that the IRS will examine an R&D credit position. Original tax returns that include R&D credit positions have not been more likely to be examined than those not that do not include R&D credit positions. Amended tax returns claiming R&D credits that are used in the years under examination have been more likely to be examined. If examined, R&D credits may be allowed or disallowed, in whole or in part. If credits are allowed, the IRS may consider the taxpayer’s other tax positions to identify additional tax liability, but only to the extent of offsetting the credit. This has been uncommon.
  2. Disallowed credits. It is possible the IRS would examine and disallow some or all the R&D credits. Credits that have been appropriately identified and supported are generally allowed. Credits that aren’t often aren’t.
  3. IRS penalty and interest. If the IRS disallows a credit it may assess a penalty if it finds that the credit was either claimed through negligence or the disregard of rules or regulations, or results in a substantial understatement of income tax. Generally, this penalty equals 20 percent of the credit disallowed, i.e., of the tax the IRS believes was underpaid. The IRS may also assess interest due on that 20 percent from the date that the tax should have been paid, but this has not been our experience.

Back to top
 
What documentation is needed to claim R&D credits?  A taxpayer claiming an R&D credit must retain records in sufficiently usable form and detail to substantiate that the expenditures claimed are eligible for the credit.
 
BDO can help determine whether and to what extent your records meet the standards IRS examiners typically apply and, if not, what other evidence you may be able to adduce to support your credits.
 
Although IRS agents are not required to follow them, the standards outlined in IRS audit techniques guides provide some signposts:
Back to top
 
How can BDO help? Self-evaluation & complimentary BDO R&D Review  Companies interested in the R&D tax credit can take this short evaluation to determine if they qualify.
 
Companies that would like to see if they qualify for the payroll tax credit should immediately contact RDTaxCredit@BDO.com, because to benefit now they must file the proper return by:
  • June 30, 2017, and take the offset on their October 31, 2017 Form 941 filing;
  • September 30, 2017, and take the offset on their January 31 Form 941 filing.

BDO offers a simple, complimentary review that provides businesses information needed to make an informed decision about whether and how to pursue R&D tax credits generally, and the payroll offset in particular.

Our team of R&D software developers, engineers, scientists, accountants, and lawyers have helped thousands of companies claim over $3 billion in R&D benefits, and we’ve supported more than 90 percent of those benefits on examination by tax authorities.
  Get a Complimentary R&D Review

Back to top
 
For more information, please contact one of the following practice leaders:
 

Chris Bard 
National Leader 

 

Jonathan Forman
Principal

 

Jim Feeser
Managing Director

 

Hoon Lee
Partner

  Chad Paul
Managing Director   

Patrick Wallace
Managing Director 

  David Wong Principal     

Pages