10/11/2012
Tax Incentives For Manufacturers
Presented by: Dean Zerbe and David Ji alliantgroup,LP
Who are we?
• National Consulting Firm • Focused on supporting CPA firms nationwide
• alliantgroup - Houston (national office), New York, Boston, LA, Atlanta, Orange County, San Francisco, San Diego, Seattle, Chicago, Toledo, Denver and Miami
• alliantgroup - Has over 325 professionals nationwide – Former “Big Four Partners” and Managers – CPAs and Attorneys (Dedicated Tax Controversy Team – 16+ attorneys) – Architects, Engineers, Software Programmers, Chemists, Biologists, etc.
• alliantgroup - Only specializes in government sponsored incentive programs.
• alliantgroup - Only works with CPA firms – Be your back office – Introduce specialized tax incentives to your clients
Mark Everson joins
Served as Commissioner of Internal Revenue from 2003 until 2007 Appointed Vice Chairman for alliantgroup Will advise alliantgroup on strategic, operational, and client service initiatives
“Many companies do not take advantage of all the tax incentives to which they are entitled. alliantgroup can help. Based on my meetings with alliantgroup personnel and a number of the accounting professionals with whom they work across the country, it is clear the firm has achieved a great deal since its founding and is well positioned for further expansion.” – Mark Everson
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Dean Zerbe, J.D., LLM National Managing Director- alliantgroup– Washington, D.C.
Dean Zerbe is National Managing Director for alliantgroup and is based out of alliantgroup’s Washington D.C. office. In this role, Dean is responsible for, among other things, monitoring tax-related legislative activity in Washington to help keep our clients and staff informed and help direct alliantgroup’s service offerings to ensure we are meeting client needs.
Prior to joining alliantgroup in February, 2008, Dean was Senior Counsel and Tax Counsel to the U.S. Senate Committee on Finance, where he worked closely with the Chairman (and currently Ranking Member) of the Finance Committee, Senator Charles Grassley (R-IA) on tax legislation.
Former Sr. Counsel and Tax Counsel, Senate Finance Committee: Involved with almost every major piece of tax legislation alliantgroup’s ultimate tax policy expert Focused on federal and state tax credits and incentives, and U.S. tax policy Media “go-to” source for commentary on tax policy and other issues
The Research & Development Tax Credit For Manufacturers
alliantgroup,LP
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Why the R&D Tax Credit?
• Largest government sponsored incentive • Reduction in taxes • Usually generates an IMMEDIATE source of cash • New regulations – easier for a broad array of companies to qualify • Recent case law (2009) – may expand credit for manufacturers • Small Business Jobs Act of 2010 - AMT turn-off for 2010 • Credit is available in ALL OPEN TAX YEARS (2009-2012) • Quick turnaround – typically, only 10-12 weeks to perform study, depending on the size of the client • Among the most misunderstood tax incentives
Example
• Mold manufacturer in Michigan – S-Corporation with 2 shareholders (90%/10%) – Annual sales: $32MM – Annual payroll: $11MM • Large local CPA firm had not considered this client for R&D Tax Credits • alliantgroup conducted a 4-year R&D study and found $1,000,000+ in Federal R&D Tax Credits
R&D Credits Executive Summary
• ~20,000 firms annually claim the credit • California reported the most activity with Michigan and Illinois following • Manufacturers claimed $5.8 B out of $8.3 B (70%) • IT took 16% of the credit • State R&D credits—38 and counting – Good: LA, CA, IN, MN, NY, NJ – Not as good: OH, MI, IL, PA, CT
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Manufacturers
• Plastic injection molding • Machine builders • Metal fabrication • Tool & die design • Prototype design • Pattern shops • Precision machining • Engineered solutions • Foundries • Metal stamping • Flavor/fragrance • Other metal forming • Food and consumer • Contract packaging goods • Contract manufacturers • Chemical manufacturers • Automotive • Medical Device • Electronics and subassemblies • Defense Contractors
R&D—Background Discussion
CLAIMING THE R&D CREDIT 1) Identify and qualify eligible projects
2) Quantify the eligible expenditures for each project 3) Documentation and substantiation
What Qualifies?
Traditional Definition Tax Definition
Discovery Test Four Main Requirements
1. New or Improved Business Component 2. Technological in Nature 3. Elimination of Uncertainty 4. Process of Experimentation
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#1—New or Improved Business Component
Business Component Purpose Matrix
The Project’s The Purposes of the R&D Activities related to the… Business Component Function Performance Reliability Quality Durability
Product Process Software Technique Formula Invention
Qualified Activities—Examples
• Design and development of the following: • Electronic Discharge Machining – Molds, Dies, Jigs, Fixtures – Wire • Quality assurance Activities: – Probe – Testing and validating designs of molds, • Computer Numerical Control (“CNC”) program dies, jigs and fixtures design and development; – Testing and validating machining • Programmable Logic Controllers (“PLC”) procedures program design and development; and – Testing and validating computer controls • Safety testing of product for durability and • Improving molds, dies, jigs, and fixtures aimed quality to create a different use / product • Developing and testing new coating systems • Designing and developing new tooling: • Production equipment development, – Computer aided design (“CAD”) implementation, and testing activities; – Automation systems – 3-D solid modeling (most commonly – CNC machining called “SolidWorks”); and – Scanning – Finite Element Method Analysis. – Rinsing systems • Designing, developing and testing of new
tooling machinery • Surface finishing technique modifications • Designing / implementing new health and safety procedures or equipment
Qualified Research Expenditures (QREs)
• Wages – Form W-2, Partnership Earnings subject to SE Tax, Schedule C – Excludes 401(k) & benefits • Supplies – Cost to fabricate prototypes / items consumed in R&D process • 65% of Contract Research – Fees paid to outside consultants / engineers / software developer
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WAGES
• Employees performing the research activity • Directly Supervising the research – Reviewing technical aspects of projects – Providing design input – Participation in meetings • Directly Supporting the research – Prototype development – Operating trials – Recording test data – Maintaining technical project files
SUPPLY COSTS
• Materials used in the conduct of the research and development – Costs of prototypes/samples – Costs of tooling (molds, dies, jigs, fixtures) – Raw materials or components used during development before commercial production – TG Missouri and Trinity Costs
CONTRACTOR COSTS
• Payments to non-employees to conduct contract research – Design, Engineering, Prototyping, Testing services – Services must be performed within the US – Must analyze the contractual relationship
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Mechanics
For every $1,000,000 of qualified research expenditures (QRE’s): –Up to $65,000 in Federal R&D tax credits –Additional state credits may be available –Refundable credits in NY, LA, MN, AZ –Strong credits in IN, CA, NJ, RI, and others
If credits cannot be used in the year they are generated: –Federal: 20 year carryforward; 1 year carryback (5 years for 2010 credits)
What’s New?
Alternative Simplified Credit
• Enables more companies to secure R&D credits • Reduces burden on claimants for historical records • Can only be elected on original returns – Protective election can be made
Declining R&D Spending 2006 2007 2008 2009 QRE $2M $1.75M $1.5M $1.25M 50% "base"------$875K Creditable amount------$375K Credit (14%)------$52,500 Effective credit rate------4.2%
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Small Business Jobs Act (HR5297)
. “The small business bill will allow thousands of the most innovative and leading small and medium companies to keep hundreds of millions of dollars in their pockets. For the first time small and medium business will no longer be barred by AMT from taking the research and development tax credit, as well as dozens of other general business credits.” ~ Dean Zerbe
Eligible small business under 50 million gross receipts Tax provisions: • Effective 38c turn-off • 5 year carry back • Signed into law September 27, 2010
Recent Case Law
In the past year, numerous Taxpayer friendly decisions have been issued by the Courts on R&D tax credit cases. These include:
Union Carbide Corp. vs. Comm’r. U.S. vs. McFerrin Fed ExCorp. vs. U.S. TG Missouri Corp. vs. Comm’r. Trinity Indus., Inc. v. U.S.
Case Study #1
Background: Industry: Manufacturing Product : Aluminum extrusion manufacturer Entity Type: C-Corp Year business started: 1980 4 year Avg Gross Receipts: $73,200,000 Total Labor: $9,300,000
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Case Study #1
Sampling of Qualified Activities:
• Two Step Anodizing Project: undertaken to design and develop a manufacturing process to provide the Company with the ability to produce components which exhibited an increased UV resistance.
• Split Shape Project: undertaken to develop a manufacturing process to extrude a complex shape. The Company evaluated the shape design and developed three dies capable of producing three shapes for subsequent assembly as opposed to a single die and single shape.
Case Study #1 Qualified Research Expenses:
Salary of $776,700 and Supplies of $53,300 for a total of $830,000 Base year %: 0.47% Base amount: $344,000 (Average GR X 0.47%) 50% limitation: $415,000
Credit Calculation: Qualified Expenses $830,000 Less 50% limitation ( 415,000) Total 415,000 Credit (20% of 415,000) $83,000
Case Study #2
Background: Industry: Radio Frequency Products Product : Electromagnetics Entity Type: S-Corp Year business started: 1996 4 year Ave Gross Receipts: $2,442,468 Total Labor: $738,769
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Case Study #2
Sampling of Qualified Activities:
• Ventilation Panel Project: To design and develop an EMI/RFI Shielded Ventilation Panel to allow for greater ventilation airflow than a standard panel. Project requirements included that the ventilation panel be utilized in a number of different electronic applications, and to ensure the differing galvanic protection capabilities for each design configuration.
• New Products Cluster: The projects contained in the New Products Cluster related to the design, development, and testing of a series of new products utilizing innovative technology to enhance the functionality, reliability, and durability of the company’s product lines.
Case Study #2 Qualified Research Expenses:
Salary of $189,999 for a total of $189,999 Base year %: 3.95% Base amount: $96,477 (Average GR X 3.95%) 50% limitation: $94,999
Credit Calculation: Qualified Expenses $189,999 Less Base Amount ( 96,477) Total 93,522 Credit (20% of 93,522) $18,704
Case Study #3
Background: Industry: Manufacturing Product : Custom equipment for mixing, grinding, and drying of material. Entity Type: C-Corp Year business started: 1966 4 year Ave Gross Receipts: $14,000,000 Total Labor: $3,400,000
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Case Study #3
Sampling of Qualified Activities:
• Mixer Project: To design and develop a mixer for large amounts of material with increased residency time in the mixer to achieve uniform heating requirements and consistency.
• Dryer Project: To design and develop a combination co-flow dryer and grinder for the concrete industry that is patent pending.
Case Study #3 Qualified Research Expenses:
Salary of $1,000,000 and Supplies of $500,000 for a total of $1,500,000 Base year %: 4.66% Base amount: $650,000 (Average GR X 4.66%) 50% limitation: $750,000 Credit Calculation: Qualified Expenses $1,500,000 Less 50% limitation ( 750,000) Total 750,000 Credit (20% of 750,000) $150,000 ALSO MN CREDIT $ 73,000
Case Study #4
Background: Industry: BioMedical Device Product : Hip, Knee, Extremities, and Biologic Implants. Entity Type: S-Corp Year business started: 1950 5 year Ave Gross Receipts: $211,500,000 Total Labor: $60,300,000
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Case Study #4 Sampling of Qualified Projects:
• Knee Implant Device: The goal of the project was to engineer and develop an improved knee-replacement implant comprised of more durable materials and an improved range-of-motion. • Hip Implant Device: The goal of the project was to engineer and develop an improved hip implant with improved durability and increased range-of- motion. • External Fracture Fixation System: The goal of the project was to engineer and develop a less-obtrusive fracture fixation system that decreased patient pain and improved healing. • Multi-Use Compression Screws: The goal of the project was to engineer more-durable compression screws for utilization in a broader range of implant devices. • Biologic Grafts: The goal of the project was to design and develop a grafting system that improved skin and ligament regrowth following injury or surgery.
Case Study #4 Qualified Research Expenses: Salary of $17,150,000; Supplies of $1,750,000; Contractors of 6,000,000; for a total of $24,900,000 Base year %: 3.81% Base amount: $8,581,000 (Average GR X 3.81%) 50% limitation: $12,450,000
Credit Calculation: Qualified Expenses $24,900,000 Less 50% Limitation (12,450,000) Total 12,450,000 Credit (20% of 12,450,000) $ 2,490,000
Case Study #5
Background : Industry: Plastic Injection Molding Product : Contract Manufacturer of Thermoplastic Parts Entity Type: S-Corp Year business started: 1989 4 year Ave Gross Receipts: $32,000,000 Total Labor: $11,000,000
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Case Study #5 Sampling of Qualified Activities:
• Air Tran Project: The Air Conveyance System project was undertaken to develop an automated process to convey molded plastic components from production machines to an assembly machine through an air-driven system of tubes • Cap and Spout Torque Project: The C&D Cap and Spout Torque Assembly Machine project was undertaken to develop a semi-automatic assembly machine to torque a plastic cap onto a plastic spout. • Rockline Tub Retrieval Project: The Rockline Tub Retrieval project was undertaken to develop a new operating process and design improvements for an existing side-entry robot to account for a new mold design.
Case Study #5 Qualified Research Expenses: Wages of $2,020,000 Base year %: 0.78% Base amount: $257,000 (Average GR X 0.78%) 50% limitation: $ 1,010,000
Credit Calculation: Qualified Expenses $2,020,000 Less Base Amount (1,010,000) Total 1,010,000 Credit (20% of 1,010,000) $202,000
Case Study #6
Background: Industry: Tooling Engineering Product : Custom Metal Stamping Entity Type: C-Corp Year business started: 1980 4 year Ave Gross Receipts: $3,186,007 Total Labor: $1,541,850
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Case Study #6
Sampling of Qualified Activities:
• Straight Pin Project: To develop a manufacturing process to produce a straight pin from .050 diameter spring temper wire. Project requirements included cutting the part to a sharp point without deforming the diameter.
• Retaining Spring Project: To develop a manufacturing process to produce a retaining spring from .039 diameter music wire. Project requirements included improving the angles to compensate for the part to be stress relieved.
Case Study #6 Qualified Research Expenses:
Salary of $527,155 for a total of $527,155 Base year %: 4.60% Base amount: $146,556 (Average GR X 4.60%) 50% limitation: $263,578
Credit Calculation: Qualified Expenses $527,155 Less Base Amount ( 146,556) Total 380,599 Credit (20% of 263,578) $52,716
The Interest Charge- Domestic International Sales Corporation For Manufacturers
alliantgroup,LP
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IC-DISC STRUCTURE
• Must be a U.S. Corporation – Want to Incorporate in a State without corporate taxation (Delaware and Nevada are the most common); • Can only have one class of stock with at least $2,500 of par or stated value on each day of the taxable year – IC-DISC should open a bank account with more than $2,500 in said account. • Timely Election to be treated as IC-DISC – Must file Form 4876A (requires unanimous shareholder consent)
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Taxation of an IC-DISC and its s/h
• Owner-managed exporting company creates a tax- exempt IC –DISC • Exporting Company pays IC- DISC a commission • Exporting company deducts commission from ordinary income taxed at 35% • IC DISC pays no tax on the commission • IC-DISC can pay a dividend in current or future tax year • Shareholders pay income tax on dividend at the capital gains rate of 15%
Structuring an IC-DISC
• S-Corporations – IC-DISC and exporter can be established as brother/sister companies; or – IC-DISC and exporter can be established as a parent/subsidiary companies. • Parent/subsidiary relationship can be helpful to avoid possible taxable events in the future. – Tax Savings is 20% of commissions identified • C-Corporations – IC-DISC and exporter must be established as brother/sister companies to get the full benefit. – Tax Savings is 29.75% of commissions identified
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Qualification as Export Property
• The property must be manufactured, produced, grown, or extracted in the U.S.; • The property must be held primarily for use outside of the U.S.; and • The property must have at least 50% U.S. Content
Manufacturing Requirement
• The IC-DISC must deal with export property that is Manufactured, Produced, Grown or Extracted in the U.S. (includes Puerto Rico and U.S. possessions) – Manufactured includes: • Substantial transformations – making paper from woodpulp, screws from steel rods, or the canning of fish • Operations that are substantial in nature and are generally considered to be manufacturing • Safe harbor - conversion costs (direct labor and factory burden including packaging or assembly) account for 20% or more of the COGS or inventory costs
Manufacturing Requirement
• What if you are a stereo speaker manufacturer who assembles speakers (subcomponents are all made by foreign manufacturers). Does this constitute manufacturing? • What if you are a stereo speaker manufacturer who assembles speakers (subcomponents are all made by foreign manufacturers) – who then ships the product to Mexico for finishing touches. The product is returned to the U.S. before being exported to Japan. Does this constitute manufacturing?
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Foreign Destination Requirement
– The sale or lease of property or services in question must ultimately be for use outside of the United States – The IC-DISC can give the goods to a freight forwarder or distributor as long as the ultimate destination is outside the U.S. • What issues can arise? • What about A&E services?
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U.S. Content Requirement
• No more than 50% of the fair market value of the export property may be attributable to imported articles – What type of problems can arise? – Do you always know the origin of all component parts?
Maximizing the IC-DISC Benefit
• The transfer price between the U.S. exporter and the IC-DISC must be calculated under one of the three following methods: – 50% Foreign Trade Income – 4% Foreign Trading Gross Receipts – Section 482
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SIMPLIFIED IC-DISC EXAMPLE
• Facts: > Qualified export receipts ……….…....$5 million > CGS ……………………..……….…....$3 million > Gross margin ………….…………..….$2 million > S, G & A ………………………….…....$1.5 million > Foreign Trade income ………………..$500,000 > IC-DISC commission – 50% FTI: $250,000 – 4% QER: $200,000 • Exporting Company deducts $250,000 saving tax of $87,500. • IC-DISC income of $250,000 taxed at 15% ($37,500). • Permanent net tax benefit of $50,000 (87,500 – 37,500). – 10% of FTI
Maximizing the IC-DISC Benefit
• Pricing method chosen is required on a transaction by transaction basis (TxT) • Grouping • Expense Allocations (861) • Marginal Costing • Neither the Gross Receipts method nor the FTI method may be applied in a way that causes, in any taxable year, a loss to the related supplier
Maximizing the IC-DISC Benefit
• The methodology used by the IC-DISC to determine the maximum amount of commissions can be changed year by year or transaction by transaction. • Drilling down to the transaction level can maximize the tax savings for your client!!!
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IC-DISC Case Study – Military Sales
Background: Industry: Military Equipment Product : Guidance Systems Entity Type: S-Corporation Total Sales: $11,815,136 Total Exports: $8,930,918
IC-DISC Case Study – Military Sales
• After a sales order takes place, commercial materials that are purchased and items that are manufactured in house all converge on the production floor. Next, several sub-assemblies and quality inspections take place and the products are shipped to the company’s client, who then ships the products outside the U.S.
• Certain sales of spare parts and maintenance items were not qualified for consideration in the IC-DISC analysis
IC-DISC Case Study – Military Sales
Export Data: Qualified Export Sales $8,930,918 Export COGS $5,143,508 Export Deductions $1,148,587 Export Profits $2,638,823
Commissions: Commission Calculated $1,319,412 Benefit $263,882
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IC-DISC Case Study – Manufacturer
Background: Industry: Manufacturing Product : Pet Foods Entity Type: S-Corporation Total Sales: $789,011,620 Total Exports: $75,563,611
IC-DISC Case Study – Manufacturer
• Raw materials were transformed into pet food products at the company’s facilities by measuring, filtering, forming, and dehydrating blends. Then, all export property was shipped directly from the company’s manufacturing plants to its foreign destination.
• Some export products, such as samples and other investments were not included in the IC-DISC analysis.
IC-DISC Case Study – Manufacturer
Export Data: Qualified Export Sales $75,563,611 Export COGS $64,442,337 Export Deductions $4,198,252 Export Profits $6,923,346
Commissions: Commission Calculated $3,461,683 Benefit $692,337
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alliantgroup, LP is an independent consulting firm that works with CPA firms and their clients to ensure they receive the full benefit of all available Federal and State government sponsored incentive programs, such as the Research and Development tax credit, the Extraterritorial Income Exclusion, the IC-DISC, the Domestic Production Deduction, the Training Credit, and Enterprise Zone Incentives.
For more information, visit our website at www.alliantgroup.com
David Ji Managing Director alliantgroup, LP 713.877.9600 [email protected]
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