Hidden Tax Strategies For Savvy Business Owners June 28, 2016 The webinar will begin at 1:30 p.m. CT

Bruce Stubbs, JD, LLM Vice President AGH Specialized Tax Solutions

Adam Manlove Manager, Tax Services

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About the Speaker

Bruce Stubbs, JD, LLM Vice President AGH Specialized Tax Solutions 20 years legal/tax consulting experience Specialized knowledge in R&D tax credit, cost segregation, and repair regulations

About the Speaker

Adam Manlove Manager, Tax Services Handles business tax planning and compliance Member of AICPA, KSCPA and YPW

Learning Objectives

Identify the business circumstances that can allow the implementation of new tax strategies.

Learn how R&D tax credit, cost segregation, and IC-DISC can benefit your business.

Understand updates to the PATH Act for bonus depreciation and Section 179 expensing.

R&D TAX CREDIT

Federal Credit Benefit

Benefit averages $0.065 per dollar spent on Qualified Research Expenses (QREs).

IRC §38 - General business credit

IRC §39 - 1-year carryback, 20-year carryforward

Dollar-for-dollar reduction in tax Subject to AMT limitations

• Eligible small business (ESB) exception starting in 2016

PATH Act of 2015

PERMANENT

Retroactive to amounts paid or incurred after 12/31/2014

No changes to credit percentage rates or methods

2 additional options for some to utilize the credit: Offset against AMT Offset against payroll tax

PATH Act of 2015 (Cont.)

Ability to offset Alternative Minimum Tax (AMT) allowed Applies to: Tax years beginning after Dec. 31, 2015

Limited to: “Eligible small businesses” (ESB) – defined as:

i. Corporation - the stock of which is not publically traded,

ii. Partnership, or iii. Sole proprietorship, and iv. Prior 3-year avg. annual gross receipts do not

exceed $50 million

PATH Act of 2015 (Cont.)

Ability to utilize the credit to offset payroll taxes Applies to: Startup companies Tax years beginning after Dec. 31, 2015

Limited to: “Qualified small businesses” (QSB) – defined as:

i. Corporation, partnership, or individual, ii. Gross receipts < $5 million, and iii. No gross receipts for any tax year preceding the

5th tax year period ending with the current tax year

PATH Act of 2015 (Cont.)

Payroll tax credit is equal to the least of: 1) Amount specified by the taxpayer < $250,000, 2) Research credit determined for the tax year, or 3) If a QSB other than a partnership or S corp., the

amount of the business credit carryforward under §39 from the tax year.

Credit Qualification Myths

Must “discover” something beyond what’s known in the industry False – “Discovery Test” is no longer the standard.

Only performing “white lab coat” type activities in a high-tech or bio-tech company qualifies.

False – Anyone who satisfies the 4-Part Test can qualify.

Must be successful and product must be available for sale False – Neither are required to qualify for the credit.

Government contractors don’t qualify. False – Anyone who satisfies the 4-Part Test can potentially

qualify. o Need to be “at risk” and “retain rights” o Contract terms are key.

Applicable Industries

Applies to all industries, including: Aircraft Agriculture Apparel Automotive Chemical Computer software Cosmetics Defense contractors Electronics

Engineering Equipment & machinery Food & beverage Manufacturing Medical Oil & gas Pharmaceutical Telecommunications Tooling, molds & dies

Study Examples

Packaging films – 3D and holographic Bee Shotgun – Developed a ‘gun’ to launch a shell filled with non-lethal smoke to disperse bees on power poles Pet products – Puppy pads, soaps, odor removers (chemical formulas) Formulas – Food & beverage service providers, flavor formulations, new & replacement ingredient selection, organic and natural foods Electric fans – Residential and industrial - motors, blade & case designs Defense contractor – Switch components & wiring harnesses for weapons Original equipment manufacturers (OEMs):

Cable assemblies & throttle controls – Motorcycles and riding lawn mowers

Plastic tubing – Medical devices & equipment

R&D 4-Part Test

• Must be present at beginning of project • Uncertainty concerns: capability, methodology, or

appropriateness of design

Test # 1 Elimination of

Uncertainty

• Physical or biological sciences, computer science or

engineering

Test # 2 Technological in

Nature

• New or improved business component as to: function, performance, reliability or quality

• Not qualified if relates to: style, taste, cosmetic or seasonal design factors

Test # 3 Permitted Purpose

• Evaluate 1 or more alternatives to resolve uncertainty. • Substantially all activities (> 80%) constitute elements of a

process of experimentation.

Test # 4 Process of

Experimentation

Qualified Activities

Idea Generation

Product Design

Prototype Build & Testing

Final Approval

Idea Generation: • Concept

design • Technical /

performance specifications identified

• Technical team meetings

Prototype Design: • 3D modeling • Technical design

meetings • Production

capability assessment

• New tooling design & development

Prototypes: • CAD analysis • Product mock-up • Destructive or non-

destructive testing • QA testing • Life cycle testing • Field testing

Final Approvals: • Design • Performance specs • Safety review • Certifications

Polling Question #1

IC-DISC

IC-DISC = Interest Charge Domestic International Sales Corporation

IC-DISC: What Is It?

IC-DISC is an IRS-approved tax strategy that can provide cash to exporters and their owners through tax savings.

“The last remaining export incentive…” Ryan L. Losi

Key Elements

Open to domestic exporters who meet criteria

Relatively easy to create/administer

“Paper corporation”

Tax exempt

Dividends qualify for reduced tax rate.

Foreign Trading Gross Receipts (FTGR)

Qualified export receipts that include:

Export property

Supporting services

Interest on qualified export assets

Non-US engineering/ architectural services

Export Property

US grown, produced or manufactured Mainly for sale outside US More than 50% of FMV attributed to US content

Qualified Export Assets

At least 95% of DISC assets at year-end must be qualified export assets: Trade Receivables Temporary Investments Producer Loans

Potential Tax Savings

Producer/exporter pays commission

to IC-DISC

IC-DISC pays dividend to

shareholders Permanent tax

savings

Typical Structure – S Corporation/Partnership

Commission

Dividend U.S. Exporter IC-DISC

Owner(s)

Typical Structure – C Corporation

Commission

Tax Savings

Dividend

U.S. Exporter IC-DISC

Owner(s)

Tax Savings Example

Foreign trading gross receipts $4,000,000 Cost of goods sold 2,500,000 Gross margin $1,500,000 Allocable operating/G&A expenses $500,000 Export sales net income $1,000,000 IC-DISC commission is greater of: 50% of export net income $500,000 4% of export receipts $160,000

Tax Savings Example (Cont.)

IC-DISC commission $500,000 Federal tax savings at 39.6% $198,000 IC-DISC dividend distribution $500,000 Federal tax cost at 23.8% (119,000) Net tax savings $79,000

Tax Deferral/Producer Loan

IC-DISC commission functions like a loan.

Producer deducts interest paid to DISC.

Tax deferral “cap”

Shareholder pays “interest charge” to IRS.

Maintenance Steps

I. Maintain separate books & records.

II. Timely commission calculation & maximization

III. Timely fund movement

IV. Producer loan documentation, if applicable

V. Tax preparation

Costs

One-time implementation costs: $6,000 - $10,000

Annual maintenance costs:

$4,000 - $8,000

*IMPORTANT – Benefits only for shipments after formation

Polling Question #2

COST SEGREGATION

Cost Segregation Defined

Formal engineering process accepted by the IRS

Identifies building costs and land improvement costs traditionally depreciated over 39 years for Nonresidential Real Property or 27.5 years for Residential Rental Property

Re-allocates a significant amount of the “building” costs to asset classes with shorter depreciation lives (accelerated depreciation)

Qualifying costs are assigned to 5, 7, and 15 year lives

Results in: Accelerated depreciation deductions Reduced tax liability Increase in cash flow

Benefits of Cost Segregation

Increase cash flow with accelerated deductions.

Benefits of Cost Segregation (Cont.)

Cost segregation studies accelerate deductions.

Studies do not increase overall depreciation deductions.

Total capitalized costs for a building & land improvements will fully depreciate with or without a study performed.

Benefit: Time Value of Money “A dollar today is worth more than a dollar tomorrow.”

When to Perform a Study

Most properties will benefit: • New construction • Acquisitions • Existing properties – “Look-back” and “catch-up” • Leasehold improvements • Renovations • Green / LEED projects Study is not recommended if: Owner plans on selling the property within the first 3-5 years of ownership because of depreciation recapture.

Property Reclass Percentages

Property Type Typical Reclass %’s Assisted Living / Ambulatory Facility 15 - 25%

Apartment / Multi-Family Building 15 - 30% Automobile Dealership 20 - 35%

Bank Buildings 25 - 35% Computer Data Center / Technology Center 20 - 45%

Distribution 5 - 15% Fitness Center / Health Club 20 - 45%

Golf Course 20 - 40% Grocery Stores 20 - 30%

Healthcare / (Medical / Dentist / Diagnostic) 30 - 40% Hospitality / Hotels 20 - 35%

Industrial / Manufacturing 30 - 45% Office Building 15 - 30% Printing Facility 15 - 35%

Research and Development 20 - 50% Restaurants (Single or Multiple) 20 - 38%

Retail (Department / Specialty Store) 20 - 30% Self Storage Facility 20 - 45%

Shopping Center 15 - 30% Theater 20 - 35%

Warehouse 10 - 15%

Example: Hotel

Type: New Construction – Current Year Study Cost: $4,505,035

Placed in Service: 2014 % Reclassified: 30.5%

1st Year Additional Depreciation $797,530

1st 5 Years Additional Depreciation $1,128,571

1st Year Tax Savings Benefit $315,822

1st Five Years NPV Tax Savings Benefit $437,760

Overall NPV Tax Savings (Net Present Value)

$243,002

Example: Apartment Complex

Type: Acquisition – Current Year Study Year Acquired: 2013

# of units: 10 Buildings / 132 Units Purchase Price: $5,476,000 % Reclassified: 24.64%

1st Year Additional Depreciation $754,765

1st 5 Years Additional Depreciation $1,001,894

1st Year Tax Savings Benefit $298,132

1st Five Years NPV Tax Savings Benefit $384,202

Overall NPV Tax Savings (Net Present Value)

$292,220

Example: Car Dealership

Type: Renovation / Remodel of Showroom – Current Year Study Cost: $2,237,000 Placed in Service: 2013 Study Performed: 2013 % Reclassified: 23.8%

1st Year Additional Depreciation $311,472

1st 5 Years Additional

Depreciation $447,208

1st Year NPV Tax Savings Benefit $123,031 1st Five Years NPV Tax Savings Benefit $170,414

Overall NPV Tax Savings (Net Present Value)

$123,787

Increased importance

8 building systems specifically identified by new Repair Regs.: 1. HVAC systems 2. Plumbing systems 3. Electrical systems 4. All escalators 5. All elevators 6. Fire protection and alarm systems 7. Security systems 8. Gas distribution system 9. Other structural components identified in published

guidance in the Federal Register or in the Internal Revenue Bulletin

FINAL TANGIBLE ASSET REPAIR & DISPOSITION REGULATIONS

Effective dates

Final regulations are generally effective for taxable years beginning on or after Jan. 1, 2014. These regulations are mandatory and not elective! Apply to amounts paid or incurred in taxable years

beginning on or after Jan. 1, 2014 for: • Materials and supplies • De minimis safe harbor election • Certain facilitative costs • Safe harbor for small taxpayers • Election to capitalize repair and maintenance

costs 49

General Framework

Materials and supplies

Reg. §1.162-3

Capital expenditures

in general Reg.

§1.263(a)-1

Costs to acquire or produce tangible property

Reg. §1.263(a)-2

Costs to improve tangible property

Reg. §1.263(a)-3

Dispositions/ General asset

accounts Reg.

§1.168(i)-1, 7, and 8

“BAR” Test

Opportunity for retirement loss or disposition deductions

“BAR” Test – Reg. §1.263(a)-3

Improvement = Capitalize

Betterment

Adaptation

Restoration

OPPORTUNITY TO CLAIM RETIREMENT LOSS OR DISPOSITION DEDUCTIONS

Tangible Asset Repair Regulations

Case Study Example #1

53

Automobile Dealership Remodel Remodel Cost $2,550,000 Cost Segregation Study on Remodel:

Additional 1st Yr. Deductions - $568,579 Additional 1st Yr. Tax Savings - $224,589 Overall Net Present Value Savings - $224,348

Fixed Asset Study: Retirement Loss Deductions - $612,249 Removal Cost Deductions - $81,367 Total Additional Deductions - $693,616 Estimated Tax Savings - $274,672

Total Savings = $499,020

Appendix

54

Final Regulations Examples Betterment - Reg. §1.263(a)-3(j) Adaptation – Reg. §1.263(a)-3(l)(3) Restoration – Reg. §1.263(a)-3(k)(7)

Betterment Examples

Betterment Examples - Regulation §1.263(a)-3(j)(3) Betterment?

#1

Amelioration of pre-existing condition or defect. Remediation of soil contamination - unaware at time of purchase Yes

#2

Not amelioration of pre-existing condition or defect. Removal and replacement of asbestos insulation with new insulation that is no more efficient or effective than the asbestos insulation

No

#3 Regularly scheduled maintenance shortly after purchase No

#4 Minor repairs shortly after purchase No

#5 Bringing assisted living facility up to higher standards after purchase Yes

#6 Building refresh look & layout No

In the course of the building refresh replacing and reconfiguring display tables & racks Yes #7 Building refresh similar to example #6 No

At same time increase storage space, add loading dock and second overhead door Yes

#8 Substantial remodel of stores Yes

#9 Relocation and reinstallation of cash registers No

#10

Relocating and reinstallation of equipment with additional components that increase capacity Yes

#11 Meeting newly imposed earthquake resistance standards Yes

#12 Add concrete lining to walls of meat processing plant to correct seepage No

Betterment Examples (Cont.)

Betterment Examples - Regulation §1.263(a)-3(j)(3) (cont’d)

Betterment? #13 New roof membrane No

#14 Reinforce columns and girders increasing load-carrying capacity of 2nd floor storage

Yes

#15 Doubling the depth of a channel at harbor facilities from 10 ft. to 20 ft. Yes

#16 Redredging channel subject to siltation (from 18 ft. to 20 ft.) No

#17 Redredging and increasing channel from 18 ft. to 25 ft. - increased capacity 25%

Yes

#18 Remove drop-ceiling and repaint original ceiling No

#19 Add stairway and mezzanine to add additional selling space to building Yes

#20 Replacement of 2 of 10 HVAC units that are 10% more efficient No

#21 Adding insulation making building 50% more energy efficient Yes

#22 Add drive through service area to a restaurant Yes

#23 Costs incurred during betterment to patch holes and repaint walls Yes

Adaptation Examples

57

Adaptation Examples - Regulation §1.263(a)-3(l)(3)

Adaptation? #1 Convert manufacturing facility into showroom Yes #2 Remove walls to combine 3 leased retail spaces into 1 No #3 Repaint walls and refinish floors in anticipation of selling No

#4 Remediate contamination after closing manufacturing plant No Regrade land for residential development Yes

#5 Reconfigure retail pharmacy to add walk-in medical clinic Yes #6 Convert part of retail grocery store to a sushi bar Yes

#7 Convert portion of hospital emergency room to outpatient surgery center

Yes

Restoration Examples

58

Restoration Examples - Regulation §1.263(a)-3(k)(7) Restoration?

#1 Replace walk-in freezer components disposed of through abandonment and loss recorded

Yes

#2 Replace walk-in freezer components disposed of through sale and loss recorded Yes

#3 Restoration after casualty loss deduction Yes

#4 Restoration after casualty basis adjustment for insurance proceeds Yes

#5 Casualty repair in excess of casualty loss No

#6 Restoration of property allowed to fall into state of disrepair Yes

#7 Rebuild of property to like-new condition before end of class life - freight cars No

#8 Rebuild of property to like-new condition after end of life - freight cars Yes

#9 Heavy maintenance - aircraft - after end of class life but not to like-new condition No

#10 Replacement of major component / substantial structural part Yes

#11 Repair performed during restoration Yes

#12 Removal costs - no loss taken on disposition of old USTs Yes

#13 Replace power switch assembly on drill press No

#14 Replace entire roof Yes

#15 Replace roof membrane No

Restoration Examples

59

Restoration Examples - Regulation §1.263(a)-3(k)(7) Restoration?

#16 Replace 1 of 3 furnaces in HVAC system No

#17 Replace the only chiller in an HVAC system Yes

#18 Replace 3 of 10 roof-mounted HVAC systems No

#19 Replace sprinkler system Yes

#20 Replace entire electrical system Yes

#21 Replace 30% of electrical system No

#22 Replace all toilets and sinks Yes

#23 Replace 8 of 20 sinks No

#24 3-year plan to remodel hotel including repairing, repainting & retiling walls Yes

#25 Replace 100 of 300 exterior windows comprising 8.3% surface area of building No

#26 Replace 200 of 300 exterior windows comprising 16.67% surface area of building Yes

#27 Replace 100 of 300 exterior windows comprising 30% of surface area of building Yes

#28 Replace lobby floors comprising < 10% sq. footage of entire building No

#29 Replace floors in all public areas comprising 40% of total building square footage Yes

#30 Replace 1 of 4 elevators No

#31 Replace 1 of 4 elevators and claim partial disposition loss Yes

Polling Question #3

PATH ACT

PATH Act: Changes to Sec. 179 Expensing

Prior Law $500,000 maximum expense

Was set to drop to $25,000 for 2015 $2,000,000 investment phase-out

Was set to drop to $200,000 for 2015 Qualified Real Property

$250,000 maximum expense No carryover to 2015 tax years

PATH Act: Changes to Sec. 179 Expensing

PATH Act Changes $500,000 maximum expense and $2,000,000 investment phase-out

Retroactively extended and made permanent Adjusted for inflation ($500,000 / $2,010,000 for 2016)

Permanently extended expensing of Qualified Real Property

Removed $250,000 expensing limitation starting 2016 Removed air conditioning and heating units from list of ineligible property

PATH Act: Changes to Bonus Depreciation

Prior Law 50% bonus depreciation set to expire 12/31/14 Real property eligible for bonus depreciation

Must meet definition of Qualified Leasehold Improvement Property

PATH Act: Changes to Bonus Depreciation

PATH Act Changes Bonus depreciation extended

50%: 2015-2017 40%: 2018 30%: 2019

Real property eligible for bonus depreciation 2015 – no change Beginning 2016 – Must meet definition of Qualified Improvement Property

PATH Act: Changes to Bonus Depreciation

Qualified Improvement Property Improvement to interior portion of a building Placed in service after date building was first placed in service Excludes improvements for:

Enlargement of building Elevator or escalator Internal structural framework

PATH Act: Changes to Bonus Depreciation

Qualified Improvement Property – Changes from prior law

Property does not have to be subject to a lease Need not be placed in service more than 3 years after building placed in service Structural components benefiting a common area are no longer excluded. Potential to take bonus depreciation on 39-year property

PATH Act:15-year Property

Prior Law 15-year recovery period for qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property set to expire at 12/31/14

PATH Act Changes Retroactively extended and made permanent the 15-year recovery period Defined the same as prior law

Polling Question #4

Thank you!

Bruce Stubbs, JD, LLM Vice President AGH Specialized Tax Solutions Bruce.Stubbs@aghsts.com linkedin.com/in/brucestubbs 316.291.4149

Adam Manlove Manager, Tax Services Adam.Manlove@aghlc.com linkedin.com/in/adammanlove1 316.291.4074

Visit AGHUniversity.com and view our upcoming webinars. Questions not about the content? Email Mike.Ditch@aghlc.com