Author: Amy Thompson

You don’t have to wear a white lab coat to claim the federal research and development tax credit if you meet the four criteria outlined in Internal Revenue Code Section 41 and its regulations. Learn why failing to explore this credit may be leaving money on the table.

Many manufacturing companies fail to take advantage of the generous research and development (R&D) tax credit simply because they don’t have staff working in a lab. The Internal Revenue Service’s (IRS) definition of R&D is codified at Internal Revenue Code Section 41 and its related regulations — and it may not be exactly what you think it is.

From 2018 to 2027, the estimated value of R&D tax credits to be claimed by U.S. companies is estimated at $163 billion, with $148 billion of that going to corporations.

You can take advantage of this tax credit as long as your company performs activities such as the following:

• Redesigns its production process to be more efficient.
• Introduces artificial intelligence or robotics into your manufacturing process.
• Develops software that enhances your company’s processes or procedures.
• Designs, constructs or tests product prototypes.
• Develops second-generation or improved products.

This list is not all-inclusive. According to the IRS, many activities may qualify if they are performed in the United States and meet the following four-part test.

Part 1. Permitted purpose

The IRS test is to create a new or improved product, business component or process that increases performance, function, reliability, composition or quality or that reduces costs for your company. It does not have to be new to your industry.

Development of internal use software may meet the permitted purpose test if it:

• is an innovation that provides economically significant results;
• requires a certain amount of economic risk and use of resources to develop when recovery of the cost is uncertain over a reasonable time; and
• is not commercially available for the intended purpose, although commercially available software may be eligible if it is significantly modified.

Part 2. Technological in nature

The research must fundamentally rely on the hard or physical sciences, such as engineering, physics, chemistry, biology or computer science.

Part 3. Uncertainty eliminated

You must be able to demonstrate that you’ve attempted to eliminate any uncertainty about the usefulness of the development, improvement or design.

Part 4. Process of experimentation

You must be able to demonstrate during the research process that you’ve experimented and evaluated alternatives. This may have been done through research techniques like modeling, simulation, trial and error or some other method.

Documenting R&D Activities

Claiming the credit requires a lot of supporting documentation, however. It is worth taking the time to assess whether the amount of tax relief you’ll get is worth the effort. For example, you’ll need to determine how much of a credit your company is eligible for, how difficult it will be to document your company’s R&D activities, whether the credit can be used to offset alternative minimum tax liability and whether you can claim previously unused credits.

Many, if not all, manufacturers may find they can reduce their taxes by taking advantage of the federal R&D tax credit. In addition, many states have an R&D credit that is available to manufacturers. It’s worth investigating and we can help. Contact us today to determine whether you should be claiming this credit.

WASHINGTON – The U.S. Treasury Department and Internal Revenue Service (IRS) released guidance today clarifying the tax treatment of expenses where a Paycheck Protection Program (PPP) loan has not been forgiven by the end of the year the loan was received.

Since businesses are not taxed on the proceeds of a forgiven PPP loan, the expenses are not deductible. This results in neither a tax benefit nor tax harm since the taxpayer has not paid anything out of pocket.

If a business reasonably believes that a PPP loan will be forgiven in the future, expenses related to the loan are not deductible, whether the business has filed for forgiveness or not.  Therefore, we encourage businesses to file for forgiveness as soon as possible.

In the case where a PPP loan was expected to be forgiven, and it is not, businesses will be able to deduct those expenses.

“Today’s guidance provides taxpayers with greater clarity and flexibility,” said Secretary Steven T. Mnuchin.  “These provisions ensure that all small businesses receiving PPP loans are treated fairly, and we continue to encourage borrowers to file for loan forgiveness as quickly as possible.”

“Nothing in life is certain except death and taxes.” — Benjamin Franklin

That saying still rings true roughly 300 years after the former statesman coined it. Yet, by formulating a tax-efficient investment and distribution strategy, retirees may keep more of their hard-earned assets for themselves and their heirs. Here are a few suggestions for effective money management during your later years.

Less Taxing Investments

Municipal bonds, or “munis,” have long been appreciated by retirees seeking a haven from taxes and stock market volatility. In general, the interest paid on municipal bonds is exempt from federal taxes and sometimes state and local taxes as well (see table).¹ The higher your tax bracket, the more you may benefit from investing in munis.

Also, consider investing in tax-managed mutual funds. Managers of these funds pursue tax efficiency by employing a number of strategies. For instance, they might limit the number of times they trade investments within a fund or sell securities at a loss to offset portfolio gains. Equity index funds may also be more tax efficient than actively managed stock funds due to a potentially lower investment turnover rate.

It’s also important to review which types of securities are held in taxable versus tax-deferred accounts. Why? Because the maximum federal tax rate on some dividend-producing investments and long-term capital gains is 20%.²In light of this, many financial experts recommend keeping real estate investment trusts (REITs), high-yield bonds, and high-turnover stock mutual funds in tax-deferred accounts. Low-turnover stock funds, municipal bonds, and growth or value stocks may be more appropriate for taxable accounts.

The Tax-exempt Advantage: When Less May Yield More

Would a tax-free bond be a better investment for you than a taxable bond? Compare the yields to see. For instance, if you were in the 25% federal tax bracket, a taxable bond would need to earn a yield of 6.67% to equal a 5% tax-exempt municipal bond yield.
Federal Tax Rate	12%	22%	24%	32%	35%	37%
Tax-exempt Rate	Taxable-equivalent Yield
4%	4.55%	5.13%	5.26%	5.88%	6.15%	6.35%
5%	5.68%	6.41%	6.58%	7.35%	7.69%	7.94%
6%	6.82%	7.69%	7.89%	8.82%	9.23%	9.52%
7%	7.95%	8.97%	9.21%	10.29%	10.77%	11.11%
8%	9.09%	10.26%	10.53%	11.76%	12.31%	12.70%
The yields shown above are for illustrative purposes only and are not intended to reflect the actual yields of any investment.

Which Securities to Tap First?

Another major decision facing retirees is when to liquidate various types of assets. The advantage of holding on to tax-deferred investments is that they compound on a before-tax basis and therefore have greater earning potential than their taxable counterparts.

On the other hand, you’ll need to consider that qualified withdrawals from tax-deferred investments are taxed at ordinary federal income tax rates of up to 37%, while distributions — in the form of capital gains or dividends — from investments in taxable accounts are taxed at a maximum 20%.2 (Capital gains on investments held for less than a year are taxed at regular income tax rates.)

For this reason, it’s beneficial to hold securities in taxable accounts long enough to qualify for the favorable long-term rate. And, when choosing between tapping capital gains versus dividends, long-term capital gains are more attractive from an estate planning perspective because you get a step-up in basis on appreciated assets at death.

It also makes sense to take a long view with regard to tapping tax-deferred accounts. Keep in mind, however, the deadline for taking annual required minimum distributions (RMDs).

The Ins and Outs of RMDs

The IRS mandates that you begin taking an annual RMD from traditional individual retirement accounts (IRAs) and employer-sponsored retirement plans after you reach age 72.3 The premise behind the RMD rule is simple — the longer you are expected to live, the less the IRS requires you to withdraw (and pay taxes on) each year.

RMDs are now based on a uniform table, which takes into consideration the participant’s and beneficiary’s lifetimes, based on the participant’s age. Failure to take the RMD can result in a tax penalty equal to 50% of the required amount. Tip: If you’ll be pushed into a higher tax bracket at age 72 due to the RMD rule, it may pay to begin taking withdrawals during your sixties.

Unlike traditional IRAs, Roth IRAs do not require you to begin taking distributions by age 72.³ In fact, you’re never required to take distributions from your Roth IRA, and qualified withdrawals are tax free, although withdrawals prior to age 59½ are generally subject to a 10% additional tax. For this reason, you may wish to liquidate investments in a Roth IRA after you’ve exhausted other sources of income. Be aware, however, that your beneficiaries will be required to take RMDs after your death.

Estate Planning and Gifting

There are various ways to make the tax payments on your assets easier for heirs to handle. Careful selection of beneficiaries of your accounts is one example. If you do not name a beneficiary, your assets could end up in probate, and your beneficiaries could be taking distributions faster than they expected. In most cases, spousal beneficiaries are ideal because they have several options that aren’t available to other beneficiaries, including the marital deduction for the federal estate tax.

Also, consider transferring assets into an irrevocable trust if you’re close to the threshold for owing estate taxes. In 2020, the federal estate tax applies to all estate assets over $11.58 million. Assets in an irrevocable trust are passed on free of estate taxes, saving heirs thousands of dollars. Tip: If you plan on moving assets from tax-deferred accounts, do so before you reach age 72,3 when RMDs must begin.

Finally, if you have a taxable estate, you can give up to $15,000 per individual ($30,000 per married couple) each year to anyone tax-free. Also, consider making gifts to children over age 14, as dividends may be taxed — or gains tapped — at much lower tax rates than those that apply to adults. Tip: Some people choose to transfer appreciated securities to custodial accounts (UTMAs and UGMAs) to help save for a grandchild’s higher education expenses.

Strategies for making the most of your money and reducing taxes are complex. Your best recourse? Plan ahead and consider meeting with a competent tax advisor, an estate attorney, and a financial professional to help you sort through your options.

¹Capital gains from municipal bonds are taxable, and interest income may be subject to the alternative minimum tax.

²Income from investment assets may be subject to an additional 3.8% Medicare tax, applicable to single-filer taxpayers with modified adjusted gross income of over $200,000 and $250,000 for joint filers.

³This age was increased from 70½, effective January 1, 2020. Account holders who turned 70½ before that date are subject to the old rules.

Higher income investors need to plan for the 3.8% “unearned income Medicare contribution” tax. This 3.8% tax was enacted as part of the 2010 health care overhaul.

Some Details

The tax applies only to taxpayers with modified adjusted gross income (AGI) above these levels: $200,000 (single/head of household), $250,000 (married filing jointly/surviving spouses), or $125,000 (married filing separately). The tax is calculated on the lesser of net investment income or the amount of modified AGI in excess of the threshold.

Example. Bill’s modified AGI is $250,000, $50,000 more than the $200,000 threshold for his single filing status. His net investment income is $60,000. Bill will owe the 3.8% tax on $50,000 since that amount is less than his $60,000 net investment income.

Net investment income generally includes interest, dividends, capital gains, annuities, royalties, and rents. It also includes income from “passive” trade or business activities, such as pass-through income from limited partnerships, S corporations, and limited liability companies in which a taxpayer does not materially participate.

Strategies

Taxpayers will have to plan carefully to minimize their exposure to the tax. Various timing strategies may be effective, especially if modified AGI is close to the threshold. Other strategies that may be helpful include:

• Increasing involvement in profitable trade or business activities so that material participation can be shown
• To the extent possible, offsetting capital gains with losses
• Investing in municipal bonds, since tax-exempt interest is not included in net investment income or modified AGI for purposes of this tax
• Maximizing pretax contributions to retirement plans

Of course, taxes are only one factor to consider when weighing investment decisions.

The SBA recently released the Paycheck Protection Program (PPP) Loan Forgiveness Application along with some key clarifications in completing the application process. The Forgiveness application is intended for small business owners whom received a PPP loan as part of the CARES Act.

The PPP Forgiveness application is comprised of 11 lines used to calculate the amount of forgiveness a small business owner is eligible for.  All or part of the PPP loan may be forgiven as long as the small business used the funds for payroll, business mortgage interest, rent or utilities.

The newly-released application essentially asks for the payroll and qualifying non-payroll costs that the business spent over the eight-week period since receiving PPP funds. The amount of forgiveness may be reduced depending on whether a business reduced pay for their employees greater than 25 percent, or if the business owner failed to bring back the same number of full-time employees.

The final step in the application process is verification that the business owner allocated at least 75 percent of the PPP funds for payroll costs, and the remaining 25 percent for mortgage interest, rent or utilities.

To learn more about completing the Paycheck Protection Program Loan Forgiveness application, please contact us.