How to Begin Your Year-end Tax Planning Despite Gridlock in Washington
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The past few months have been marked by political strangleholds, creating prolonged uncertainty around taxes. In such an environment, business owners and entrepreneurs across the United States may feel stifled or limited in how they can develop and implement effective tax strategies. Even though it appeared in November that Congress had reached a consensus on making permanent certain incentives, those too were sent back to the deliberation room.
In response, a revised bill extending the incentives for one year was recently passed in the House by a vote of 378 to 46. While it’s unclear how the Senate and the White House will respond to the revised measure, the IRS has warned Congress that further delay will result in a late start to what is already supposed to be a difficult 2015 filing season. Though the headache of having to make decisions in murky times is not fully subjugated, businesses would be prudent to consider the tax opportunities that can be leveraged to maximize their tax position.
Important Extender Incentives for Businesses
Research and Development Incentive. One extender that should be on the forefront of businesses planning is the Research and Development credit (R&D). This important tax break is widely believed to bolster the U.S. economy by creating and sustaining job growth and by incentivizing companies to innovate and remain technologically competitive. The House extenders bill would extend this credit through the end of 2014.
In general, the credit is equal to a percentage of wages paid for the performance of qualified research, supplies used in development efforts and payments made to third parties for design and testing. If money is being spent to find ways to make a product faster, cheaper, or more efficient, there is likely opportunity for a tax credit under the R&D rules.
Capital Investment Incentive. Falling under section 179, this incentive allows a taxpayer to immediately expense the entire cost of an investment (like equipment or software) in the year of purchase, instead of writing off the cost over the course of three to 15 years. Similarly, section 168(k) – otherwise known as “bonus depreciation” – allows for immediate expensing of 50 percent of the cost.
Pending approval, bonus depreciation could also be retroactively instated for 2014. How would this then net out? The maximum deduction a company can make under section 179 would remain at $500,000 for 2014, with a dollar-for- dollar investment phase-out beginning at $2,000,000. Without it, bonus depreciation disappears, and both 179 thresholds are substantially reduced to $25,000 and $200,000, respectively.
Section 199. For entrepreneurs and companies in the business of manufacturing goods, the section 199 incentive is an attractive option for savings. This incentive allows for an additional 9 percent deduction of the lesser of taxable income, or 9 percent of "qualified production activities income (QPAI)." QPAI is equal to the amount by which gross receipts from eligible US manufacturing activities exceed related expenses.
But what if your manufacturing processes occur outside of the US? There still may be opportunity to claim a deduction. The tax code states that the production must occur "in whole or in significant part" within the US. A facts and circumstances test is applied to the manufactured goods, assessing the amount of relative value and cost added to the product within the U.S. as compared to overseas.
The Interest-Charge Domestic International Sales Corporation (IC-DISC). How can US companies with profitable export sales increase after-tax cash flow by up to 20 percent? By converting what would be ordinary income--taxable at a maximum rate of 39.6 percent-- to capital gain income taxable at a maximum rate of 20 percent.
For example, in order to qualify, a company creates a separate entity organized as a C-Corporation. The C-Corporation then applies for IRS approval to be treated as an "IC-DISC." Once approved, the IC-DISC is deemed to participate in the exporting process of the operating entity and earns a “commission,” which is tax free to the C-Corporation until the earnings are distributed to shareholders. Benefits of the IC-DISC can only be derived after the IC-DISC has been formed. Therefore, this may be something to consider for tax year 2015.
Legislative delay may have created some uncertainty for 2014 planning. However, opportunities, such as the section 199 deduction and the IC-DISC, currently remain in place and represent legitimate strategies for companies looking to optimize cash flow for 2015 and beyond.