Sec.174 Amortization Update

With Legislation Building Support, What Should Taxpayers Do NOW?

Introduction
Everyone’s asking — Will mandatory Sec. 174 amortization be repealed? Business owners, the scientific community, and tax professionals all hope the answer is yes, but there is still a way to go. Three different bills are making waves in Congress — and bipartisan support is encouraging — but for the moment, the amortization requirement remains in effect.

As we continue to watch Congress for updates, taxpayers must seek expert guidance who can advise them of their options during this waiting game.

The Situation: Mandatory Amortization of Sec. 174
Before the Tax Cuts and Jobs Act (TCJA) of 2018 was passed, taxpayers could choose to immediately deduct their Section 174 Expenses or to capitalize and amortize them over a period of 5 years.

The TCJA contained a provision mandating that – beginning in Tax Year 2022 – Section 174 expenses must be amortized over 5 years or 15 years. Section 174 Expenses may no longer be immediately deducted.

By amortizing the deduction over 5 years, taxpayers will see a higher net taxable income initially. Generally, taxpayers will pay more taxes in year 1 and year 2, but not more overall. In fact, most taxpayers will “break even” by year 3 and pay little to no tax in that year and beyond. Smaller firms and start-ups will likely feel the impact of the increased tax liability more deeply, even if it is only short-term.
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Listen To Audio Podcast: What CPAs Must Know About Mandatory Amortization Of Section 174 Expenses

This audio segment is produced by the Capstan Tax team led by Bruce Johnson and Terri Johnson, Partners, Capstan Tax.

Capstan R&D Tax Credit experts Lindsey King and Carly Coker return to the pod to discuss the implications of Sec. 174 amortization.

Interplay Between Sec. 174 and Sec. 41

The Way We Were (i.e. Sec. 174 treatment before TY 2022)

The Current Situation

Rev. Proc. 2023-11 and What Makes it Taxpayer-Friendly

The Impact of Mandatory Amortization

What the IRS Will Be Looking For

The R&D Tax Credit as a Mitigating Factor

Follow This Link To Listen To This Audio Podcast Anytime

How To Calculate The Federal R&D Tax Credit

The Federal Research and Development (R&D) Tax Credit is an activities-based tax credit for companies that that incur R&D expenses in the United States.

Eligible taxpayers may claim qualifying expenses – wages, supplies, contract research, cloud hosting – for a dollar-for-dollar reduction in tax liability.

The Credit may be calculated using the Regular Research Credit (RRC) Method, or the Alternative Simplified Credit (ASC) Method.

The choice of Method shouldn’t be taken lightly, and taxpayers are encouraged to consult an R&D provider to advise based on specific facts and circumstances.

​​Regular Research Credit Method (RRC) [Section A, Form 6765]
Under the RRC Method, the Federal Credit is 20% of a Company’s Current Year QREs that exceed a Base Amount.

The calculation is quite complex:

Step 1: Determine the time period from which you will be gathering data — the “Base Period.”

In a base analysis all companies start as “80s Base Companies.”

1984 is your starting point. Ask these two questions:
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How to Determine R&D Tax Credit Eligibility: 4 Part Test

Takeaways

Since the R&D Tax Credit is activities-based, eligibility is determined by testing the research activities a company performs.
In order to qualify for the Credit, a research activity must pass all four parts of the Four-Part Test:

Part #1: The research activity must be related to developing a new or improved business component for a “qualified purpose”—i.e. related to new or improved functionality, quality, reliability, or performance. The development or improvement doesn’t have to be brand new or vast in scope.

Part #2: The research activity must be undertaken for the purpose of eliminating some uncertainty related to appropriate design, method, or capability. Even research that is ultimately unsuccessful in eliminating uncertainty may still qualify.

Part #3: The research activity must involve some Process of Experimentation designed to resolve the uncertainty. The “Substantially All” Test adds a quantitative aspect to Part #3.

Part #4: The research activity must fundamentally rely on principles of physical sciences, biological sciences, computer science, or engineering, or their applications.

Certain activities are automatically excluded from Credit eligibility, including foreign and funded research.
Thorough documentation is required to demonstrate compliance with all Four Parts of the Test. The recent Little Sandy Coal case serves as a cautionary tale.

​​Introduction: An Activities-Based Credit

The Federal Research and Development (R&D) Tax Credit is an activities-based tax credit for companies that incur R&D expenses in the United States. Based on IRC § 41 & § 174, the Credit is intended to incentivize innovation and experimentation.
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The Inflation Reduction Act

Webinar Is Today! You Can Still Register As Webinar Begins In Less Than One Hour
Date: April 26th
Time: 12:00PM EST
Webinar Title:The Inflation Reduction Act of 2022: Transforming 179D and 45L
CPE Credit For Attendees: 1 CPE Credit
Field of Study: Taxes
Program Level: Beginner/Intermediate
Cost: Compliments Of Capstan Tax, Complimentary Education

Description:
The passage of the Inflation Reduction Act of 2022 (IRA) has transformed energy-efficient tax incentives for commercial real estate. The IRA will alter and amplify both the 179D Deduction and the Section 45L Tax Credit. In this all-new webinar, we will compare the current version of each incentive to the “IRA Version” of the incentive, addressing changes to reference standards, calculation of incentives, documentation procedures, and more. New exciting initiatives including utility sales tax recovery, C-PACE, and more will also be discussed. Numerous real-life case studies will be reviewed, and a variety of reference tables will be provided.

Learning Objectives:
• Compare the requirements for claiming the 179D deduction under both the old and new laws
• Understand how the 179D deduction is calculated under the Legacy Program and under the IRA
• Recognize other changes to 179D under the IRA, including the elimination of partial deductions and theestablishment of deduction reset
• Compare the requirements for claiming the 45L Tax Credit under both the old and new laws, and theassociated differences for single-family and multifamily dwelling units
• Become familiar with solar energy incentives, the benchmarking process, and C-PACE
• Learn about NYC’s Carbon Emissions Bill, and recognize potential implications in New York and beyond
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R&D Tax Credits In Manufacturing Industry

The R&D Tax Credit is a general business tax credit for companies that incur R&D expenses in the United States. With a dollar-for-dollar reduction in federal and state tax liability, the credit offers up to 10 cents in benefit for every qualifying dollar identified in a performed study. Any business in almost any industry can be eligible for the R&D Credit if it meets the Four-Part Capstan Criteria, and the results of this permanent, powerful credit can be quite significant.

New Or Improved Business Component
A Company in the architectural and structural metals manufacturing industry designs and fabricates various products for use in building applications. The Company undertook a project to develop a metal wall panel system for a newly constructed commercial building. The Company created the system utilizing aluminum composite panels to improve structural performance and corrosion
resistance. Additionally, the Company designed the panels to include an air and moisture barrier for increased functionality and reliability.

Elimination Of Uncertainty
The Company encountered uncertainty in panel design, as it was unclear which panels would best provide the high impact resistance required for increased structural support against elements and weight. Additionally, the Company faced uncertainty in the design of tooling and fixtures to properly form, hold, and test the panels during the fabrication process.
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Real Estate Tax Incentives And Strategies

The wide variety of real estate tax opportunities available can be overwhelming. To make sure you’ve considered all potential sources of benefit, review our expansive checklist.

​​☐​ Accelerated Depreciation

Look-back studies via 3115, best results achieved for properties in service under 15 years
Recall depreciation potential inherent in 754 Step Ups and 1031 Exchanges, as well as tax-exempt property

​​☐​ Bonus Depreciation
100% for properties placed-in-service between 9/28/17-12/31/2022
Acquired assets eligible under the TCJA

​​☐​ Bonus-Eligible QIP (Qualified Improvement Property)
QIP placed-in-service on or after 1/1/2018 is 15-year property and bonus-eligible – major implications for renovations/retrofits

​​☐​ Expensing Options under the Tangible Property Regulations (TPRs)
DeMinimus Safe Harbor (Itemized invoices will be helpful)
Small Taxpayer Safe Harbor
Routine Maintenance Safe Harbor (via 3115)
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Tax Cuts And Jobs Act (H.R.1) of 2017

The Tax Cuts and Jobs Act was signed into law on December 22, 2017. This marked the first comprehensive tax law reform since 1986, and has had an impact on every American taxpayer and industry. The TCJA brings new opportunities, as well as some challenges, to the commercial real estate community. Most of the legislation became effective January 1, 2018, with two important exceptions.

Capstan Tax Strategies is at your service as we navigate these changes together. We’ve done a thorough review of the TCJA- Tax Cuts and Jobs Act and analyzed the legislation most likely to have a major impact on our clients and colleagues. (Click HERE if you’d like to read the Act in full).

Corporate Tax Rate
The top corporate tax rate of 35% was reduced to 21%. Corporate AMT was eliminated.
Interest Deduction Limitation
For years beginning 1/1/2018, companies are subject to a limitation on deductible interest expense. The deductible amount is capped at 30% of adjusted taxable income, after certain adjustments.
Companies that are “real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing or brokerage trade or business” may “elect-out” of this limitation. However, any company that elects-out of the interest limitation will be required to depreciate its real property using the Alternative Depreciation System (ADS).

For a company electing-out for tax years after 12/31/17, the ADS lives below are applicable:
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What CPAs Must Know About Rev. Proc. 2023-11 And The Mandatory Amortization Of Section 174 Expenses

Summary

174 Research and Experimentation (“R&E”) Expenses paid or incurred in taxable years beginning after 12/31/2021 cannot be immediately deducted. They must be amortized over 5 years, or 15 years in the case of foreign R&E. There are several implications to this change:
1) This mandatory change will result in a short-term increase in taxable income;

2) Since there was previously no difference between Section 162 and Section 174 deductibility, many businesses will not even realize they are now affected;

3) Taxpayers have a limited time to take advantage of Rev. Proc. 2023-11 and avoid filing the complex Change of Accounting Form 3115;

4) While a change in these rules is generally expected eventually, in the immediate term taxpayers will have to account for these changes on their 2022 tax returns; and

5) The Section 41 Research and Development (“R&D”) Tax Credit is an excellent way to mitigate the effects of mandatory amortization under Section 174.

The Background: Section 174 and Section 41

In order to understand the impact of this legislation, it’s crucial to understand the relationship between Section 174 Expenses and Section 41 Expenses.

Section 174 Expenses are known as Research and Experimentation, or R&E Expenses. The expenses that fall under Sec. 174 can be divided into two categories, based on how essential each is to the activity being performed.

Section 41 Expenses are known as Research and Development, or R&D Expenses. These are known as “Direct Research Expenses,” and are what usually come to mind when you imagine research and development. Wages, supplies/materials, cloud hosting, and fees paid to 3rd party contractors are expenses integral to the research process.
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Trusted Tax Professionals

According to research by psychologists, Trust is a central part of any human relationship. Trust is a belief that a person will act and behave in certain ways. Trust in a person means that you have a feeling of confidence and security that you can depend on a particular individual. Trust is the number one characteristic desired in a tax advisor. Trust is what everyone searches for when hiring a tax professional to handle your personal information. Trust is the assured reliance on the character, ability, strength or truth of someone or something. Given challenges in the world today, the most valuable asset you can offer is trust!

Trust takes time to build. Relationships take time to build; finding people you trust is what we search for in our most valued relationships. We are taking this time to identify the people we know who are trusted to do a great job for taxpayers. Taxes are complex today. It is challenging time for tax experts and taxpayers to understand the new tax rules and legislation thrust upon us each year. Taxpayers need access to trusted tax experts in the profession. For the purposes of this blog post, we have three goals:

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Industry Alert: Notice 2022-61 Clarifies Prevailing Wage And Apprenticeship Requirements Under The IRA

On November 30, 2022, the IRS issued Notice 2022-61, providing initial guidance on the wage and apprenticeship requirements included in the Inflation Reduction Act of 2022.  The IRA established increased benefit levels for energy-efficient incentives related to EPAct 179D and 45L that may only be obtained when prevailing wage and apprenticeship requirements are satisfied.  This Notice provides additional detail regarding these requirements, associated recordkeeping, and project timing.   

The prevailing wage and apprenticeship requirements delineated in the Notice will apply to facilities for which construction begins on or after 1/30/2023.   

PREVAILING WAGE RATE REQUIREMENTS  

The “Prevailing Wage” requirement states that mechanics and laborers must be paid no less than the prevailing wages required to be paid for federal construction work.  (The wage will vary based on exact job description and geographic location.)   

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3 Cost Segregation Trigger Events In Real Estate Life Cycle

While cost segregation is useful throughout the real estate life cycle, there are certain events that tee up particularly strong cost seg opportunities. These events should automatically trigger consideration of a cost segregation study, since picking the right moment can maximize benefit.  Read on for our top 3 cost segregation study triggers – so you can proactively recognize opportunity.   

1. New Construction of Commercial Property 

Cost segregation takes advantage of the time value of money by front-loading depreciation to the early years of ownership.  As such, to maximize savings from Year 1, a cost seg study should ideally be performed as soon as a newly constructed property is placed-in-service 

Consider a newly constructed hotel placed-in-service in 2021 (100% bonus in play.)  Capstan was retained to perform a study immediately after construction was completed.   

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