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With the passage of the 2017 Tax Cuts and Jobs Act (TCJA), many clients want to know if the tax benefit of federal research credit (R&D credit) is still available.

The TCJA did not directly change the general rules related to the R&D credit.  The R&D credit is available to taxpayers who develop new or improved products, processes, and formulas.  The R&D credit can be used to directly reduce income tax liabilities for C corporations, individual owners of businesses structured as pass-through entities (i.e., S corporations and limited liability companies), and individual proprietors.

In some cases, employers may reduce a portion of their share of payroll taxes for start-up companies. This option may apply during the start-up company’s first 5 revenue years (or earlier, if the company is pre-revenue) if the business’ gross receipts is under $5 million in the year the benefit is claimed.

In the past, corporations subject to the Alternative Minimum Tax (AMT) were only able to benefit from the R&D credit to the extent that regular tax exceeded AMT.  Under the TCJA, AMT for C corporations has been repealed, thereby removing the AMT limitation on corporate use of R&D credit benefits.

Since the AMT for individuals was not repealed, the AMT R&D credit limitations still apply to many taxpayers, including S corporation owners and limited liability company members.  However, the new rules retain the special exception from the AMT limitation for certain owners of small businesses (i.e., prior 3-year average gross receipts less than $50 million).

Change in tax accounting rules related to research and experimental expenditures

Perhaps the biggest impact on research incentives resulting from the TCJA is disallowance of an immediate deduction for research expenditures.

Under the current tax treatment, taxpayers are allowed to immediately deduct research expenditures under their normal tax accounting method (i.e., cash vs. accrual).  Starting in tax years beginning after December 31, 2021, research expenses will be required to be capitalized and amortized over 5 years.  This provision could have a severe impact on the tax and cash flow planning for businesses who engage in research activities.

Please contact your Clark Nuber professional or Rene Schaefer to discuss the planning opportunities and benefits of claiming the R&D credit.

© Clark Nuber PS and Developing News, 2018. Unauthorized use and/or duplication of this material without express and written permission from this blog’s author and/or owner is strictly prohibited. Excerpts and links may be used, provided that full and clear credit is given to Clark Nuber PS and Developing News with appropriate and specific direction to the original content.

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Changes to the Qualified Improvement Property (QIP) Classification under the Tax Cut and Jobs Act

Where We Were…

Qualified Improvement Property (QIP) isn’t entirely new. The 2015 PATH Act created qualified improvement property, which is “any improvement to an interior portion of a building that is nonresidential real property if the improvement is placed in service after the date the building was first placed in service.” Excluded from QIP is any enlargement to the building, improvements to escalators or elevators and internal structural framework.  Under the 2015 PATH Act, QIP was eligible for bonus depreciation and depreciated over 39 years. In addition to QIP, there was also qualified leasehold improvement property, qualified retail improvement property and qualified restaurant improvement property. These types of qualified improvements were generally eligible for bonus depreciation and depreciated over 15 years. QIP opened up new doors for certain taxpayers who didn’t qualify under the three other improvement property types mentioned above. Companies who were leasing to related companies or who owned their own building could accelerate depreciation through bonus depreciation deductions on the improvements that qualified. QIP also removed the three-year wait period and no longer restricted the accelerated depreciation be limited to leased space; common spaces also qualified.

So What Changed with QIP?

Under the TCJA, the other three types of improvement property were removed and only the QIP classification was left for assets purchased after December 31, 2017. In removing the code sections related to the three previous types of improvement property (qualified leasehold, retail and restaurant), the TCJA neglected to also add in new code sections for QIP, which was interlinked with the old improvement property code sections. The short of it means that qualified improvement property is no longer eligible for bonus depreciation and is depreciated over 39 years. A House Ways and Means spokesperson has commented that Joint Explanatory statement reflects the intent of the House and Senate, and the error will be addressed with technical corrections. The TCJA did add that QIP is now eligible for Section 179 deduction, which is completely new for improvement property.

Next Steps

We are waiting for technical corrections to be made to match up the intention of the House and Senate to the laws for QIP, allowing the improvements to be depreciated over 15 years. In the meantime, we recommend that you work with your CPA to estimate your taxable income under the current law. If you were able to previously use a 15-year life and bonus depreciation on improvements, you should plan for the 2018 impact to taxable income under the current 39 year life/no bonus depreciation rule in case a technical correction is not made. Work with your CPA to identify other opportunities to reduce taxable income as appropriate. If you have any questions or would like more information, contact your Clark Number advisor or Jamie Witt. Jamie Witt is a senior manager in the Tax Services Group. © Clark Nuber PS, 2018. All Rights Reserved

The Change in the Standard Deduction Affects Charitable Giving

Let’s take the case of a married couple and their three basic deductions: state and local taxes, home mortgage interest, and charitable contributions. Of these three most common deductions, only the charitable deduction allows for flexibility or tax planning; the remaining are relatively fixed deductions. Our first couple earns $200,000, has $24,000 of mortgage interest and $10,000 in state in local taxes. For this couple, a $1,500 charitable contribution would reduce their taxable income and reduces their marginal tax rate from 24 to 22%. Because $165,000 taxable income is the break point between the 22 and 24 % marginal tax rate for married filing jointly taxpayers, this couple’s $1,500 deduction brings taxable income below $165,000.

Grouping Donations

Another couple, similar to the one above, but who do not have large mortgage interest, would require a larger charitable deduction to reduce taxable income to the 22 % bracket. In their case, it may be more advantageous for this couple to group their charitable contributions into one year and take the standard deduction in subsequent tax years. In order to know for certain, a tax planner would need to do the calculation based upon the fixed amounts of interest and taxes and adjusting the variable amount of charitable contribution the taxpayer is considering making. The change enacted by the Tax Cuts and Jobs Act of 2017 suspended or sharply curtailed most itemized deductions for tax years 2018 through 2025. State and local tax deductions are limited to $10,000 for the year, and home mortgage interest is limited to purchase and improvement debt up to a maximum threshold of $750,000 ($375,000 for married filing separately). These all affect taxable income before the charitable deduction, which is key to planning for the optimal benefit from charitable deductions. Each taxpayer must look at their own tax situation to determine whether total itemized deductions will provide more tax savings than the standard deduction. If the sum of the two fixed itemized deductions, mortgage interest and taxes are close to the standard deduction amount, grouping charitable contributions may be an effective tax savings strategy. The Pease amendment, which limited itemized deductions for adjusted gross income above certain thresholds, was also repealed so taxpayers must compare the full amount of itemized deductions to the increased standard deduction. Continuing with our examples above, suppose the married couple are baby boomers who are likely in their higher income years to have a dwindling mortgage, but still have high state and local taxes. With no charitable contribution, and solely considering the deductions for state and local taxes and mortgage interest, they are better off with the standard deduction. However, with a $10,000 charitable contribution deduction, itemizing is more beneficial because it is more than the standard deduction. By grouping or bundling charitable contributions into a single tax year, they can obtain even more benefit from their contributions. Instead of contributing $10,000 per year for 2018 and 2019, the couple contributes $20,000 in 2018 and nothing in 2019. This will also allow the taxpayers to qualify for the lower 24% marginal tax rate. $315,000 is the break point between the 32 and 24 percent income tax rate for individuals in 2018.

Donor Advised Funds

If a taxpayer has no preferred charity to which they normally contribute, or wants to defer deciding which charity to support, a donor advised fund (DAF) can be an ideal way to manage the grouped or bundled contributions. A DAF allows contributors to make a completed gift in one year and advise to whom distributions are made from the DAF in future periods. There are restrictions on how a DAF may be used. DAFs may not make distributions to any natural persons, may not satisfy a personal pledge (except as outlined in IRS Notice 2017-73), and may not be used to purchase memberships or tickets to fundraising events the donor/donor advisor uses to attend. However, so long as none of these restrictions are a barrier, a DAF can be an excellent tool to accommodate bundling of contributions to take advantage of the larger standard deduction created by the Tax Cuts and Jobs Act of 2017. If you have questions on how the changes in the tax law affect your personal circumstances, please call or email to make an appointment with your Clark Nuber tax advisor. We are always happy to meet with you to discuss your individual goals and help you minimize your tax liability. © Clark Nuber PS, 2018. All Rights Reserved

Cloud-Based Services, Sales Tax, and the Slow March of Recognition

For accounting professionals and many of their clients, the software or other digital services they use daily are no longer stored on local hard drives or overheated servers stuffed in a back closet. The professional world has moved on to using the cloud, but most states have still not affirmatively recognized this new-ish elephant in the computing room. In terms of the sales and use tax treatment for cloud-based services, many regional governments leave vendors, purchasers, and their advisors in a haze when searching for answers about accounting for cloud services.

Buying and Selling Cloud-Based Services

In dealing with sales tax, one of the principal tasks for any vendor is to determine the proper tax treatment for the items or services they sell in the jurisdictions where they are obligated to comply. This process is rarely simple, even with established products or services. The U.S. sales and use tax universe of 46 states and hundreds of localities often prefer to put their own stamp on the taxation of specific transactions. Cloud-based services have certainly established themselves in the marketplace, but they remain identified as specifically taxable or exempt in less than a quarter of the sales tax states. The dearth of direct guidance on the treatment of cloud-based services for sales and use tax affects sellers and buyers. Vendors struggle to determine with certainty whether cloud-based services should be taxed at all, while purchasers are left wondering if they are being overcharged or, especially in the case of business consumers, is there a use tax obligation that must be accrued?

What are States Doing About Cloud-Based Services?

As we alluded to above, there are really three varieties of states in this area: states who affirmatively identify cloud-based services, states who use existing rules to shoehorn some cloud services into existing categories of other taxable goods or services, and states who seem to ignore the existence of the cloud all together. Since lack of clarity creates fear, uncertainty, and doubt, we commend the minority of states who are on the record when it comes to sales tax and the cloud. It is important to note here that when a state affirmatively defines cloud-based services, they do not automatically apply the tax to them; some states define and impose, others define and exempt. In New Jersey, for example, the state has defined SaaS, PaaS, and IaaS, finding that none of these cloud-based service types are subject to sales tax. Indiana recently followed a similar path for SaaS. On the other hand, Washington defines “remote access software” as a SaaS type model and finds sales of it are taxable, while “digital automated services” are construed as to describe most cloud-based services and are also taxable in the Evergreen State. More commonly, states have addressed only limited factual circumstances with regards to the cloud, and many of the states in this category have only addressed SaaS. For example, Connecticut finds a service that provides remote access to information includes the provision of SaaS and is taxable as a data processing service. In West Virginia, where most services are taxable generally, the delivery of cloud-based services enjoys no specific exemption and is likely taxable at the general rate. Finally, a portion of states do not define cloud services but have yet to apply existing rules to determine taxability. For example, in Nevada, since almost no services are taxed at all, the state’s silence on the cloud implies these services are exempt as well.

A Friendly Use Tax Reminder to Cloud Loving Businesses and Professionals

As your company adopts more and more cloud-based solutions, it also runs the risk of incurring use tax obligations on those expenditures. These purchases are for services that are “consumed” in the furtherance of your company’s operations, they are typically not bought for resale. Use tax compliance should not be a new thing (if it is a new thing, the following message is even more vital), but use tax obligations regarding cloud-based services come with a twist. Many providers of cloud-based services are not collecting sales taxes, even when the services are taxable in your state. Cloud-based or not, we can all agree that vendors who don’t collect sales taxes avoid doing so for their own special reasons. With cloud-based services, the reason they don’t collect is often related to the nature of the cloud itself: the delivery of cloud-based services can be made without traditional indicia of sales tax nexus. This hearkens back to Sales Tax 101: without a physical presence, a vendor is not obligated to collect sales taxes, leaving the purchaser to self-remit use tax. One of the main selling points of the cloud is its lack of physicality in the hands of its users, so providers of cloud services often lack the physical presence in states where they sell that would otherwise obligate them to collect.

The Take-Away

The pace of legislative and administrative progress is plodding mainly by design. Deliberative bodies and bureaucrats are rarely able or advised to rush into new territory; the slow march to recognition of the cloud is only another chapter in this book. That said, the risk and consequences of poor compliance remain very real for vendors and purchasers as sales of cloud-based services continue to grow. For companies with the resources and experience to plot this minefield, carry on and keep watching for the incremental but inevitable march to clarity. If marching to the beat of the sales tax band is not your thing, consider finding a specialist who can help you and your clients avoid tripping over their own feet on the sales tax dance floor. Clark Nuber has experienced staff on hand to help you sort out cloud-based (or other types of) sales tax headaches. Contact us via our website for professional insight into your company’s situation. © Clark Nuber PS, 2018. All Rights Reserved

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