Are you familiar with cost segregation studies, IC –DISCs, R&D tax credits, accelerated depreciation methods and the Domestic Production Activities Deduction?
If not, then you may have outgrown your tax advisor and are likely not taking advantage of tax deductions available to you. It is obviously costing you money and decreasing your cash flow.
The type of business you operate will determine which would be most beneficial to you. Manufacturers may have the ability of take advantage of all of the tax incentives noted above if they also own their building.
Below are five tax strategies that may be beneficial to your company:
Cost Segregation Studies: Normally, commercial buildings are depreciated over a 39-year period and residential buildings over 27.5 years; however, components of the building may be able to be depreciated over a much shorter period of time. For example, the building’s electrical system that runs your business equipment can be depreciated over a 7-year period, instead of over 39 or 27.5 years.
It is common practice to have a cost segregation study performed by qualified professionals to break out the building into much shorter life elements, or personal property that would be depreciated over 5 or 7 years. An analysis would have to be done to determine whether the expense of a cost segregation study would be less than the tax savings, but in many cases, the cost pays for itself with the tax savings generated from the increased depreciation.
The building components would be broken down for 5, 7, 15 (land improvements) and 39 or 27.5 year asset lives. Land improvements would include parking lots, sidewalks, and fences.
If bonus depreciation was allowed in the year of service, it would even add more depreciation expense that could be taken. The recalculation of the “make-up” depreciation using the shorter lives can be taken in the next filed tax return without the need to amend prior years’ tax returns. This would net an immediate tax savings in the year it is filed.
IC –DISCs (Interest Charge Domestic International Sales Corporation): IC-DISCs are a separate domestic corporation that is formed for manufacturers that directly export products, manufacturers that sell products that are eventually exported, architectural and engineering service for structures that are constructed outside of the United States, and are pass-through entities and are privately held.
For United States exporters, it is an avenue to transfer income to the IC-DISC through a tax-deductible commission. The IC-DISC’s commissions are then taxed by the shareholders as dividends. It effectively saves tax between the shareholders’ potentially top tax rate of 39.6% and 20% as a qualified dividend plus 3.8% Medicare surtax, at the federal level. On a state level, each state recognizes an IC-DISC differently, so it depends on where or how the corporation is set up.
Research and Development (R&D) Tax Credit: The Research and development or research and experimentation (R&E) tax credit is available for the discovery of information that is for new technology for the intended purpose of developing a new or improved business component of the taxpayer’s business. A business component is any product, process, computer software, technique, formula or invention which will be held for sale, lease or license or used by the taxpayer in their trade or business.
It could be used to improve or develop a new product, improve the performance, reliability or quality of a product. Even if the activities do not produce a new product, the expenses are still eligible for the credit.
Wages, supplies, rental or lease cost of computers and contract research expenses all qualify for the gross expenses. A portion of these expenses are allocated in the calculation of the credit. This is not a deduction, but it is a dollar-for-dollar credit against taxes.
In addition to federal R&D credits, many states offer an R&D tax credit.
Accelerated Depreciation Methods: With accelerated depreciation methods, business owners can take advantage of direct write-off or bonus depreciation for machinery and equipment, furniture, and certain transportation equipment purchases. Businesses that purchase qualified improvement property, restaurant or retail property can shorten their building lives from 39 to 15 years.
During the last several years, the IRS has not approved depreciation “extenders” until the latter part of the year. This has made budgeting for the purchase of fixed assets difficult, because they were unsure whether the IRS was going to enact accelerated depreciation incentives.
Finally in 2015, the IRS approved bonus depreciation for multiple years for 2015 through 2019.For new purchases only, 50% of the cost can be written off for 2015 to 2017, 40% bonus write down in 2018, and 30% in 2019. Unlike Section 179 depreciation, bonus depreciation is available to a business even if they do not have net income. A business can opt out of certain classes of assets and not take bonus on those assets. For example, if a business wants to only take bonus on 5-year assets, but they have also purchased 7-year assets, they can opt out of the bonus depreciation for these assets. This is an annual election.
Section 179, which is the immediate write-off of the cost of the asset, can be taken on either new or used assets. It is limited to $500,000 per year, with a dollar-for-dollar phase out when total expenditures in a calendar year exceed $2,000,000.
You have to have net income in order to take Section 179. Also, all component members of a controlled group are treated as one taxpayer. The limits, noted above, also apply on a taxpayer level. If a taxpayer has several companies, and each takes Section 179 depreciation, the taxpayer is limited to $500,000 per year with the same phase outs noted previously. Important Update: The Tax Cuts and Jobs Act greatly enhanced equipment depreciation options. Check out this article for the new limits or contact us at email@example.com with questions.
Domestic Production Activities Deduction: This attractive deduction, which began in 2004 and commonly referred to as Section 199, awards taxpayers that engage in qualifying domestic activities with a 9% deduction of qualified production activities income, not to exceed 50% of W-2 wages attributable to domestic production gross receipts.
To qualify for this credit, a taxpayer’s qualifying production property must be manufactured, produced, grown or extracted in whole or in significant part in the United States. Also qualifying film production, electricity, natural gas or potable water (safe to drink) produced in the United States qualifies for the deduction. Construction of real property, engineering or architectural services performed in the United States also qualifies for this deduction.
This Section 199 deduction went from 3% of Qualified Production Activities Income (QPAI) in 2004, then 6% during 2007 through 2009, to 9% in 2010. Many taxpayers have unfortunately not taken advantage of the Domestic Production Activities Deduction, but if they didn’t, they can amend their prior three years’ tax returns. Important Update: The Tax Cuts and Jobs Act eliminated DPAD. Please check out this page for news on Tax Reform changes or contact us at firstname.lastname@example.org with questions.
If your tax advisor has not informed you of these tax incentives, please contact us and we can guide you so you can maximize your tax deductions and credits and increase your cash flow.