Tax Incentives for Manufacturers
Simulation Association
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©2010 LarsonAllen LLP
December 6, 2011
Steve Roark, CPA
Marni Spence, CPA
Overview
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• The Tax Formula
• The Research Tax Credit
• Cost Segregation &
Depreciation
• IC-DISC
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The Basic Tax Formula
Gross Receipts (Income)
$ 2,000,000
Less
Key to Savings
Deductions
(1,500,000) (reduce taxable income)
(e.g., Depreciation, COGS, Payroll, etc.)
Total Taxable Income
500,000
Income Tax Rate
Tax Due
35%
175,000
Key to Savings
$
150,000 ($ for $ savings)
25,000
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Tax Credits
Tax Check to IRS
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The Research Tax Credit
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The Research Tax Credit
• Background
– Qualified Business Components
– R&D versus R&E
– General Process
• Contracting Considerations
– Rights, Risk, Funding and Contracts
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• R&E Timeline
• Documentation
• Credit Calculation
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Overview of the Research Credit
Buzzwords: Patent, Patent Pending, New, Improved, Engineer, Coder,
Design, Test, Prototype, Alpha/Beta, Upgrade
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• Created in 1981
– Temporary part of the tax code – available through
12/31/2011
– Recent guidance has given much better definition of
what qualifies and what a valid claim must contain
– Benefit highly lucrative if claimed correctly
• Business Component
– New or Improved Product or Process
– New to client (not necessarily the world)
– Process Improvement and/or Redesign may qualify
The Picture
• Hands on, direct support &
direct supervision allowed
• Patent = safe harbor
• New to client (not to world)
• Pilot Model, Process,
Formula, Invention, or
Technique
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IRC §174
Direct Costs
In-Direct Costs
Overhead / G&A
Reimbursable Costs
No Exclusions
IRC §41 = R&E
Wages
Supplies
Contract Research
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Experimental or laboratory
sense = discover info that
eliminates “product”
development/improvement
uncertainty
Contracting Decision Tree
Contract Awarded/
Grant Received
Payment Contingent
on Successful R&E?
(Yes)
Do you have Rights
to Use R&E results?
Allowable
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Cost Plus or
Time & Materials
No, Disallowed
CLINs
Separately
Considered
No, Disallowed
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Part/Component
Fixed Price
Timeline Perspective
Market
Research
&/or Reverse
Engineering
Allowable Activities
Testing &
Analysis of
Test Results
Process of
Experimentation
to Eliminate
Uncertainty
Commercial
Production
Approval
Final Analysis of
Information to
Make a
Production
Decision
Disallowed
Activities
New Problem
Identified during
Production
May Potentially Lead
Back to R&E
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Disallowed
Activities
Industry Specific R&D Timeline
Disallowed
Activities
Allowable Activities
Disallowed
Activities
Pre-Contract Award Work
Market Research
Vendor Research
State of
Technology/Training
Reverse Engineering
Design
FAA Certification
Part 21 - Dem/Val
Program Mgt
Safety
Training
Technical Writing
Overseas R&E
Production
PreProduction Planning
Creation of new production
Machinery/Processes
Qualification Testing
Tooling up for Production
Debugging
Trouble Shooting
May Potentially Lead
Back to R&E
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ECP
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Prototypes/Mock-ups and Models
Fixtures
Testing
- CMM
- Functional / Flight Test
- Destructive Test
- HALT
Credit Claim – a 3 Step Process
Identify
qualifying
research
activities
Document
qualified
activities
Documentation creates NEXUS or a tie between activities and expenses
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Quantify
expenses related
to qualified
activities
Credit Calculation
20% Regular
$150,000
14% Alternative
$200,000
$100,000
Example of Base Period Hurdle
$50,000
2008
2009
2010
2011
Credits Offset Tax Dollar-for-Dollar & Offset 2010 AMT
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$0
LarsonAllen Approach
• Phase I - Initial Assessment
– Determine framework to establish Nexus between
qualifying activities and expenses
– Estimate potential credits
– Determine utilization of benefit
– Go/no-go recommendation
• Phase II - Substantiation
GOAL: Minimize Impact on Client – Maximize Benefit – Create Audit Support
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– Construct actual Nexus between qualifying activities and
expenses
– Document activities & Finalize Credit Calculation
– File on tax return – potentially 4 returns
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Cost Segregation
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Cost Segregation
• Why perform a cost segregation?
– Maximize tax deferral
◊ Tax deferrals are accelerated into early years
◊ $1 worth more today than 40 years from now
– Increase cash flow
◊ Tax savings in early years generates additional cash flow to
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reinvest
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Cost Segregation
• Classify separate component lives
– 39/27.5 year property re-classed to 5, 7 or 15 year
lives (see Rev. Proc. 87-56)
• Activities that benefit include:
–
–
–
–
–
New Construction
Purchase of an existing building
Additions
Renovations
Leasehold or tenant improvements
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• Benefit – More depreciation in early years
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Cost Segregation
• Example: ($3.9M building, renovation, etc.)
Federal
Year of Asset's
Depreciation
Life
before Cost Seg
1
50,000
2
100,000
3
100,000
4
100,000
5
100,000
6
100,000
7
100,000
8
100,000
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39
40
Total
5-Year
540,000
144,000
86,400
51,840
51,840
25,920
100,000
100,000
50,000
3,900,000
900,000
Federal Depreciation after Cost Seg
7-Year
15-Year
39-Year
Total
0
31,500
37,692
609,192
0
2,850
75,385
222,235
0
2,565
75,385
164,350
0
2,310
75,385
129,535
0
2,079
75,385
129,304
0
1,869
75,385
103,174
0
1,770
75,385
77,155
0
1,770
75,385
77,155
Values Repeat for Year 9 - 15
0
885
75,385
76,270
Values Repeat for Years 17 - 38
0
75,385
75,385
0
37,692
37,692
0
60,000
2,940,000
3,900,000
5-Year Depreciation Increase
35% Tax Rate (Total Savings first 5 years)
Present Value of Savings at 7%
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39-Year
2,940,000
~ 25%
Total
3,900,000
804,616
281,616
190,239
Savings
35% Tax Savings
559,192
195,717
122,235
42,782
64,350
22,523
29,535
10,337
29,304
10,256
3,174
1,111
(22,845)
(7,996)
(22,845)
(7,996)
(23,730)
(8,306)
(24,615)
(12,308)
(8,615)
(4,308)
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Sample Depreciation Property Break Out
5-Year
7-Year
15-Year
900,000
60,000
Depreciation Alternatives
• Cost Segregation
– Applied to New Construction, Renovations, Additions, Leasehold or Tenant
Improvements
– Breaks Out Items into Shorter Lives (5, 7, 15 year, etc.)
– Can Perform After the Fact
– Single Lump Sum Retro Catch Up Okay
• Bonus Depreciation – new only
– 100% of purchase price, class life of 20 years or less, thru 12/31/11
– Decreases to 50% in 2012
– Unlimited Amount
– $500K max - Purchase Price/Lease of equipment/software
– Phase out ($ for $ reduction over $2M)
– $125K max tax years beginning in 2012 – Phase out lowers to $500K
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• Section 179 – new and used
IC-DISC
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(Interest Charge - Domestic International Sales Corporation)
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IC-DISC
B
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A
• Company sells goods
• Pays a commission to the ICDISC and deducts the amount
of the commission
• DISC can loan commission
money back to exporter, or
• DISC pays a dividend to
shareholders
• Currently 15% tax rate
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IC-DISC Example
Without IC-DISC
Foreign Trading Gross Receipts
Cost of Goods Sold
Selling, General, and Admin
Export Net Income
Tax Rate
Tax Paid
With IC-DISC
10,000,000
(6,000,000)
(3,000,000)
1,000,000
35%
350,000
Foreign Trading Gross Receipts
Cost of Goods Sold
Selling, General, and Admin
Export Net Income
IC-DISC (Greater of):
1) 50% of Export Net Income
2) 4% of Export Gross Receipts
IC-DISC Commission
IC-DISC Deduction
Taxable Income
Tax Rate
Tax Paid
Combined Exporter
10,000,000
(6,000,000)
(3,000,000)
1,000,000 1,000,000
IC-DISC
Total
500,000
400,000
500,000
(500,000)
500,000 500,000
35%
15%
175,000
75,000 250,000
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IC-DISC Net Tax Savings: $350,000 - $250,000 = $100,000
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IC-DISC – Key Points
• Export sales filed as commission income via
1120 IC-DISC
• Reclassifies export sales from ordinary income
to qualified dividend
– Reduces tax rate from 35% to 15%
– $10M Exports generate minimum of $80K tax
savings, sometimes much more
• Paper corporation only
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– Customers need not know of existence
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Conclusion
• Tax credits, deductions, bonus depreciation and
other tax planning mechanisms create significant
incentives for businesses
• Recent Events:
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– Add urgency to acting now
– Are Designed for Businesses to Create Cash Flow
– Sustain Jobs and Incentivize Investment
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Discussion
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