Tuesday, March 30, 2010

The Reconciliation Act was signed into law today

As you may already know by now, the second part of the Health Care legislation (H.R. 4872 - Health Care and Education Affordability Reconciliation Act of 2010) was signed into law today, March 30, 2010.

While I'm still working on a combined write-up for the Reconciliation Act and the preceding Patient Protection and Affordable Care Act (H.R. 3590), you can access the actual laws here:
Caveat:  H.R. 3590 at times changes its own provisions (e.g., section 9001 is modified by section 10901), and H.R. 4872 goes on to further change H.R. 3590 (e.g., section 1401 of H.R. 4872 further changes section 10901 of H.R. 3590 which modified section 9001 of that Act), so read carefully!  Not exactly easy to follow.

Happy reading...

Friday, March 26, 2010

The Jobs Bill (aka the Health Care bill's quiet sibling)

With all the focus on Health Care legislation, not everyone got the message that on March 18, 2010, President Obama signed into law the Hiring Incentives to Restore Employment Act ("HIRE"). While intended to spur job growth via tax breaks to businesses that add employees and invest in equipment, it also (among other things) imposes new disclosure requirements related to foreign investments. An overview of the more widely-applicable provisions follows. For more detailed information (and we do mean detailed), readers can refer to these official sources:

Hiring and Retention Incentives
  • Payroll Tax Forgiveness for Hiring Unemployed Workers - Eliminates the employer's share of OASDI paid by a qualified employer attributable to wages paid to a qualified individual (starting with the date immediately after enactment, i.e., 3/19/10) through 12/31/10, subject to minor adjustment for wages paid through 3/31/10.
    • "OASDI" is the old age, survivors, and disability insurance tax equal to 6.2% of covered wages up to the taxable wage base ($106,800 in 2010), providing a maximum potential benefit to the employer of approximately $6,600.
    • A qualified employer is any non-governmental employer (but does include public higher education institutions).
    •  A qualified individual is anyone who (1) begins work for a qualified employer after 2/3/10 and before 1/1/11; (2) certifies by signed affidavit that he or she was employed for a total of 40 hours or less during the 60-day period ending on the date such employment began; (3) is not employed to replace another employee of the employer unless such employee separated from employment voluntarily or for cause; and (4) is not a related party with respect to the employer.
    • Coordination with the Work Opportunity Tax Credit ("WOTC") - Qualified employers may not receive the WOTC with respect to wages paid to a qualified individual during the 1-year period starting with the employee's hire date if such wages qualify under this provision unless the employer expressly elects to forgo the benefits of this provision for that person.
    • Business Credit for Retention of Certain Newly Hired Individuals in 2010 - Provides a general business tax credit for each retained "qualified invididual" (as defined above) who (1) is employed on any date during the taxable year; (2) remains employed for a period of not less than 52 consecutive weeks; and (3) receives wages during the last 26 weeks of such period that are least 80% of the wages received during the first 26 weeks of that period. The amount of this credit is the lesser of
      • $1,000 or
      • 6.2% of the wages paid by the taxpayer to the retained worker during the 52 consecutive week period referred to above.
        • The retention credit may not be carried back to a taxable year that begins prior to the date of enactment of this provision.
        • This provision is effective from the date of enactment (i.e., 3/18/10).

      Section 179 Expensing
      • Extends for one year the $250,000 maximum section 179 deduction (and the $800,000 phaseout limit) that would otherwise have dropped to $125,000 (and $500,000) in the absence of this legislation.
      • This provision is effective for taxable years beginning after 12/31/09.

      Qualified Tax Credit Bonds
      • Permits tax credit bond issuers (of Clean Renewable Energy Bonds, Qualified Energy Conservation Bonds, Qualified Zone Academy Bonds, and Qualified School Construction Bonds) to elect to treat such bonds issued after 3/18/10 as Build America Bonds and qualifying for tax credits to be paid to the issuer instead of the holders of such bonds. While primarily applicable to state and local governments, potential purchasers of such bonds should be aware of this provision if they are considering these investments and were counting on possible credits coming to them.

      Revenue Raisers
      • Foreign Account Tax Compliance
        • Reporting and withholding on certain foreign accounts - Adds a new chapter 4 to the Internal Revenue Code (comprising 4 new sections) that impose withholding and reporting requirements on persons making specified types of payments to certain foreign financial institutions and other foreign entities. The general rules are as follows: 
          • The statutory withholding rate for withholdable payments to an applicable foreign financial institution or other covered foreign entity is 30%. 
          • Withholdable payments generally include "(i) any payment of interest (including any original issue discount), dividends, rents, salaries, wages, premiums, annuities, compensations, remunerations, emoluments, and other fixed or determinable annual or periodical gains, profits, and income, if such payment is from sources within the United States, and (ii) any gross proceeds from the sale or other disposition of any property of a type which can produce interest or dividends from sources within the United States." However, this term excludes any item of income that represents income connected with the conduct of a U.S. trade or business.
          • Withholding agents are those "persons, in whatever capacity acting, having the control, receipt, custody, disposal, or payment of any withholdable payment."
          • Covered foreign financial institutions are those that do not have an agreement with the U.S. Treasury for the collection, verification, maintenance, and reporting of information about direct or indirect U.S. owners of financial accounts held by that institution. Covered other foreign entities are those that are not covered "foreign financial institutions" as noted above and (1) the beneficial owner of the payment is either that entity or another non-financial foreign entity and (2) the recipient does not qualify for a waiver of withholding. A withholding waiver is generally available if the payee provides the withholding agent with either (a) certification that the beneficial owner does not have substantial U.S. owners or (b) the name, address, and taxpayer ID number of the beneficial owner. In addition, the withholding agent must not know or have reason to know that the information provided is incorrect and must also report the above information to the IRS.
          • This provision is generally effective for payments made after 12/31/12.
        • Repeal of certain foreign exceptions to registered bond requirements - This provision actually consists of several changes related to foreign-targeted bonds and the corresponding (1) exclusion from withholding on, and (2) deduction of, the interest payments on those bonds if certain tests are met.
        • Repeal of exception to denial of deduction for interest on non-registered bonds - Repeals the exception to the denial of a deduction for interest on bonds not issued in registered form. As a result, interest deductions are disallowed attributable to obligations not issued in registered form, unless (1) issued by a natural person, (2) it has a maturity of one year or less, or (3) is not of a type offered to the public.
          • An obligation is considered issued in registered form if (1) it is registered with its issuer (or agent) and may only be transferred by surrendering the old instrument and either (a) the reissuance to the new holder or (b) the issuance of a new instrument to the new holder, (2) the right to principal and interest may only be transferred through a book entry system maintained by the issuer (or agent), or (3) it is registered with the issuer (or agent) and may be transferred through both of the foregoing methods.
        • Repeal of treatment as portfolio interest - Repeals the portfolio interest exception to withholding on interest from bonds that are not issued in registered form.
          • Portfolio interest means any interest (including OID) that is (1) paid on a registered-form obligation and for which the beneficial owner has provided the U.S. withholding agent a statement certifying that the beneficial owner is not a U.S. person, or (2) paid on a non-registered form obligation that meets the foreign targeting requirements of the code. However, it does not include interest received by a 10% shareholder, certain contingent interest, interest received by a controlled foreign corporation from a related person, or certain interest received by a bank on an extension of credit.
        • Dematerialized book-entry systems treated as registered form - Permits a debt obligation held through a dematerialized book entry system, or other specified book entry system, to be treated as being held through a book entry system for the purpose of treating the obligation as being in registered form.
          • A dematerialized book entry system is one that tracks instruments (usually electronically) without the use of physical certificates.
          • Effective for debt obligations issued after the date which is two years after the date of enactment (i.e., starting 3/19/12).
        • Disclosure of information with respect to foreign financial assets - Imposes a disclosure requirement on individuals with an interest in a “specified foreign financial asset.” This requirement is met through a statement attached to their tax return for any year in which the aggregate value of all such assets is greater than $50,000.
          • “Specified foreign financial assets” are specified accounts at foreign financial institutions. However, the following constitute such assets even if not held in an account at a financial institution: (1) stocks or securities issued by foreign persons, (2) financial instruments or contracts held for investment issued by (or having) a non-U.S. counterparty, and (3) any interest in a foreign entity.
          • However, individuals are not required to disclose interests that are held in a custodial account with a U.S. financial institution.
          • While the penalty is substantial ($10,000 plus additional amounts for continued failures, up to a maximum of $50,000 for each applicable taxable period), the penalty may be waived if the individual can establish the failure was due to reasonable cause and not willful neglect.
          • Effective for taxable years beginning after 3/18/10.
        • Penalties for underpayments attributable to undisclosed foreign financial assets - Adds a new 40% penalty on tax understatements related to undisclosed foreign financial assets. Applicable assets are those subject to mandatory information reporting where the disclosure requirements were not met. Applicable understatements are those attributable to any transaction involving such assets.
          • Effective for taxable years beginning after 3/18/10.
        • Modification of statute of limitations for significant omission of income in connection with foreign assets - Provides for an extended, 6-year, statute of limitations period within which the IRS can assess additional tax on understated income attributable to foreign financial assets. This provision applies if gross income in excess of $5,000 is omitted from an income tax return and that gross income is from assets for which foreign financial asset disclosure is required.
          • Effective for returns filed after 3/18/10 as well as for any other return for which the assessment period has not yet expired as of 3/18/10.
        • Reporting of activities with respect to passive foreign investment companies ("PFICs") - Imposes an information disclosure requirement on U.S. persons who are PFIC shareholders.
          • A PFIC is any foreign corporation if (1) 75% or more of the gross income of the corporation for the taxable year is passive income, or (2) the average percentage of assets held by such corporation during the taxable year which produce passive income or which are held for the production of passive income is at least 50%. Passive income generally includes dividends, interest, royalties, rents, annuities, and net gains on assets that give rise to those types of income.
          • Effective from 3/18/10.
        • Clarifications with respect to foreign trusts which are treated as having a United States beneficiary - Clarifies, for purposes of determining whether a foreign trust is treated as having a U.S. beneficiary, that amounts should be treated as accumulated for a U.S. person's benefit even if that person's trust interest is contingent on a future event. Also clarifies that discretion to identify beneficiaries may also cause the trust to be treated as having a U.S. beneficiary. This is important in light of disclosure requirements (as noted below).
          • Effective from 3/18/10.
        • Presumption that foreign trust has United States beneficiary - Generally creates a presumption that a foreign trust has a U.S. beneficiary if a U.S. person directly or indirectly transfers property to a foreign trust, unless the transferor provides satisfactory information to the contrary to the IRS.
          • Effective for property transfers after 3/18/10.
        • Uncompensated use of trust property - Provides that the use of trust property, including cash, by (1) the U.S. grantor, (2) U.S. beneficiary or (3) any U.S. person related to either of those two must be treated as a distribution to the extent of the fair market value of the property's use to the U.S. grantor or U.S. beneficiary, unless the fair market value of that use is paid to the trust within a reasonable amount of time.
          • The provision applies to loans made and uses of property after 3/18/10.
        • Reporting requirement of United States owners of foreign trusts - Requires any U.S. person treated as the owner of any portion of a foreign trust to submit IRS-required information and ensure that the trust file a return of its activities and provide such information to its owners and distributees.
          • Effective for taxable years beginning after 3/18/10.
        • Minimum penalty with respect to failure to report on certain foreign trusts - Increases the minimum penalty for failure to provide timely and complete disclosure on foreign trusts to the greater of $10,000 or 35% of the amount that should have been reported. In the case of failure to properly disclose by the U.S. owner of a foreign trust of the year-end value, the minimum penalty would be the greater of $10,000 or 5% of the amount that should have been reported. 
          • Effective for notices and returns required to be filed after December 31, 2009.
        • Substitute dividends and dividend equivalent payments received by foreign persons treated as dividends - Treats substitute dividends and dividend equivalents as if they were U.S.-source dividends for purposes of withholding on payments to foreign persons.
          • Substitute dividends and dividend equivalent payments are those payments that are economically the same as dividends made with respect to the underlying stock in the context of a securities lending or sale-repurchase transaction.
          • Effective for payments made on or after the date that is 180 days after 3/18/10 (i.e., starting 9/14/10).
      • Delay in Application of Worldwide Allocation of Interest - Delays the availability date of the one-time election for an affiliated group's domestic members to allocate and apportion interest expense and a worldwide group basis for purposes of determining foreign source income in the context of the foreign tax credit.
        • Election may not be made before tax years beginning after 12/31/20.
      • Time for Payment of Corporate Estimated Tax - Accelerates the timing of required corporate estimated tax payments due in July, August, or September of 2014, 2015, and 2019. This provision applies to corporations with assets of at least $1 billion as of the end of the preceding year.

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      Let me know if you have any questions or comments!

      Sunday, March 14, 2010

      "Qualified research activities" in plain English

      From talking with other CPAs and business owners, it seems pretty clear that even after all the years that the research credit has been around, the types of activities that qualify for the credit are still not widely recognized.

      For the record, it does not necessarily require teams of scientists in lab coats, rows of Bunsen burners, and electron microscopes. In fact, it can involve something as seemingly simple as trying to create a nontoxic coating for the inside of a pizza box that minimizes leakage during delivery! Hardly what many people would consider high tech research, but often research nonetheless for purposes of IRC section 41.

      Given that common misunderstanding, and in the interest of providing a relatively simple explanation to clients (and prospects) when discussing the research credit, I wrote a memorandum for that very purpose, which I'd like to share here as well.

      So, without further ado, I've reproduced it below. (Caveat: I ask that you read it as a general guide and not as a definitive treatise on the subject. It is meant strictly as a starting point for discussion, and by design does not address every possible issue...not even close.)  If you're interested in seeing whether your business might qualify, drop me a note at my email address under "About Me."

      (p.s. - While the federal credit did expire for expenditures after 12/31/09, it appears likely to be reinstated.  In addition, California's research credit is permanent, as may be other states.)


      For purposes of the credit, qualified research activities means those which satisfy the following criteria:
      • The activity is experimental or laboratory in nature,
      • For the purpose of discovering information,
        • Which is technological in nature,
        • The application of which is intended to be useful in the development of a new or improved business component
      • Substantially all of the activities of which constitute elements of a process of experimentation, relating to
        • A new or improved function;
        • Performance; or
        • Reliability or quality of a business component.
      • An activity that qualifies as research and development (R&D) is one that is experimental or laboratory in nature. This term generally includes all activities incident to the development or improvement of a product.
        • Activities represent R&D in the experimental or laboratory sense if they are intended to discover information that would eliminate uncertainty concerning the development or improvement of a product.
        • Uncertainty exists if the information available to the company at the outset does not establish either the capability or the particular method for developing or improving the product or the appropriate design of the product.
          • note: It is unnecessary that there be uncertainty as to whether the component or improvement can be designed at all; rather, there need only be uncertainty with respect to the best method of design necessary to achieve the desired result.
        • Whether activities qualify as R&D depends on the nature of the activity to which the efforts relate, not the nature of the product or improvement being developed or the level of technological advancement the product or improvement represents.
      • An activity which is for the purpose of discovering information,
        • Which is technological in nature,
          • This test depends on whether the process of experimentation (see below for definition) utilized in the research fundamentally relies on principles of the physical or biological sciences, engineering, or computer science.
          • Research does not rely on the principles of computer science merely because a computer is involved. However, research is considered to be undertaken to discover information which is technological in nature if such information expands or refines existing principles of computer science. The development or improvement of computer software can, in some cases, be considered an activity which is technological in nature.
        • The application of which is intended to be useful in the development of a new or improved business component. A business component is any product, process, computer software, technique, formula, or invention which is:
            • To be held for sale, lease or license, or
            • Used by the taxpayer in the trade or business of the company.
          • Also included in the definition of a business component are certain production processes such as any plant process, machinery, or technique for commercial production of a business component.
          • Each business component must be evaluated separately to see if its R&D qualifies under the applicable rules. Thus, any plant process, machinery, or technique for commercial production of a business component is treated as a separate business component (and not as part of the business component being produced).
          • If all aspects of the requirement of new or improved function, performance, or reliability or quality (mentioned below) are not met with respect to a business component, but are met with respect to one or more elements thereof, the term “business component” means the most significant set of elements of such product, etc. with respect to which all aspects of the requirement are met.
          • The requirement of “new or improved function,” etc. is applied first at the level of the entire business component to be offered for sale, etc. by the taxpayer. If all aspects of that requirement are not met at that level, the test applies at the most significant subset of elements of the business component. This "shrinking back" of the product is to continue until either a subset of elements of the product that satisfies the requirement is reached, or the most basic element of the product is reached and such element fails to satisfy the test.
      • Substantially all of the activities constitute elements of a process of experimentation, relating to:
          • A new or improved function;
          • Performance; or
          • Reliability or quality of a business component.
        • “Process of experimentation” means a process involving the evaluation of more than one alternative designed to achieve a result where the means of achieving that result is uncertain at the outset. This may involve developing one or more hypotheses, testing and analyzing those hypotheses (through, for example, modeling or simulation), and refining or discarding the hypotheses as part of a sequential design process to develop the overall component.
        • Qualified research does not include the following:
          • Any research conducted after the beginning of commercial production of the business component.
          • Any research related to the adaptation of an existing business component to a particular customer's requirement or need.
          • Work which is related to the reproduction of an existing business component (in whole or in part) from a physical examination of the business component itself or from plans, blueprints, detailed specifications, or publicly available information with respect to such business component.
          • Surveys and studies of the following nature: efficiency surveys, management studies, market research, testing, or development (including advertising or promotions), routine data collection, or routine or ordinary testing or inspection for quality control.
            • Testing or inspection to determine whether particular units of materials or products conform to specified parameters is quality control testing. However, quality control testing does not include testing to determine if the design of the product is appropriate.
          • Any research conducted outside the United States.
          • Research in the social sciences, arts, or humanities.
          • Funded research.
          • Activities relating to style, taste, cosmetic, or seasonal design factors.
      • If an employee has performed both qualified services and nonqualified services, only the amount of time allocated to the performance of qualified services is treated as research.
        • If substantially all of the services performed by an individual consist of R&D services, then all of that individual's time can be considered as R&D. The term “substantially all” is defined as 80% or more of the time spent by an individual on R&D activities.
      • Direct supervision and direct support of qualified activities may also constitute qualified R&D under the following circumstances:
        • Direct supervision means the immediate supervision (first-line management) of qualified research (as in the case of a scientist who directly supervises research, but who may not actually perform research). Direct supervision does not include supervision by a higher-level manager to whom first-line managers report, even if that manager is a qualified research scientist.
        • Direct support includes the services which directly assist either those engaging in actual qualified R&D or those who are directly supervising those engaged in qualified R&D. Examples include the services of a secretary typing reports describing research results and a clerk for compiling research data. Direct support of research activities does not include general administrative services or other services only indirectly of benefit to research activities. For example, services of payroll personnel in preparing salary checks of scientists, of an accountant for accounting for research expenses, of a janitor for general cleaning of a research laboratory, or of officers engaged in supervising financial or personnel matters do not qualify as direct support of research. This is true whether general administrative personnel are part of the research department or in a separate department.
      • Activities related to the development of computer software for the taxpayer's own internal use (e.g., for payroll, bookkeeping, or personnel management functions) are generally not considered qualified R&D. However, under forthcoming regulations, the development of internal-use computer software may be treated as qualified R&D only if it can established that, in addition to satisfying the general requirements for R&D treatment:
        • That the software is innovative (as where the software results in a reduction in cost, or improvement in speed, that is substantial and economically significant);
          • Note that the proposed regulations provide a slightly modified standard than the legislative history in that the software “is innovative in that the software is intended to be unique or novel and is intended to differ in a significant and inventive way from prior software implementations or methods”.
        • That the software development involves significant economic risk (as where the taxpayer commits substantial resources to the development and also there is substantial uncertainty, because of technical risk, that such resources would be recovered within a reasonable period); and
        • That the software is not commercially available for use by the taxpayer (as where the software cannot be purchased, leased, or licensed and used for the intended purpose without modifications that would satisfy the first two requirements just stated).