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Federal Incentives That Can Show You the Money

Presented by
Michael Silvio, CPA Managing Director, CBIZ MHM, LLC.

Strategic Edge Series

Seven Core Principles to Maximize the Value of Your Business During Its Life and Upon its Sale May 18th Creative Compensation Strategies to Maintain Morale and Retain Talent June 22nd Dont Be Held Captive: Go Captive to Manage Your Risk and Expenses July 20th Federal Incentives That Can Show You the Money August 17th Protecting Your Legacy with Succession Planning September 21st State Tax Nexus: No Physical Presence Required October 26th

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Michael Silvio, CPA

Michael Silvio is Managing Director with CBIZ MHM, LLC. He leads the San Diego and Orange County offices Research & Development (R&D) and Energy Incentives Tax Credit Services Group. Michael has more than 20 years of experience in public accounting and tax and has served a variety of businesses in the manufacturing, construction, professional service and not-for-profit industries. Michaels primary focus is in R&D tax credit and tax incentives areas. He has conducted over 250 research credit studies for numerous companies in various industries, and has served as a representative before the IRS and state taxing authorities to support and defend numerous research credit claims for taxpayers. He also has experience in financial accounting, reporting and management, auditing, and individual and business income tax. Michael has supervised compilations, audits and reviews for various clients, including small and medium sized businesses, in addition to providing income tax planning, consulting and compilation services. Michael is a CPA certified in California. He is a member of the American Institute of Certified Public Accountants and the California Society of Certified Public Accountants. He has a Bachelor of Arts in business administration with an emphasis in accounting from California State Polytechnic University in Pomona. Throughout his career he has authored several publications and conducted numerous presentations on current tax legislation, R&D tax credit, energy incentive issues and other tax related business incentives. He has also spoken to organizations such as the California Society of CPAs, the National Association of Manufacturers, the R&D Credit Coalition in Washington, D.C., and the American Bar Association. 3

As required by U.S. Treasury rules, we inform you that, unless expressly stated otherwise, any U.S. federal or state tax advice contained in this presentation, including charts or graphs, etc., is not intended or written to be used, and cannot be used, by any person for the purpose of avoiding any penalties that may be imposed by the Internal Revenue Service or state tax authorities. Certain portions of the presentation materials have been taken from various articles and information prepared by other sources. The information in this presentation contains trade secrets and confidential and proprietary information belonging to CBIZ and Mayer Hoffman McCann P.C or others. As a result, the information in this presentation is not to be disclosed, duplicated or disseminated in any way or any purpose other than your evaluation.

Research and Development Tax Credits Domestic Production Activities Deduction Energy Efficient Building Deduction Summary/Key Takeaways Questions

Research and Development Tax Credits

The Federal Research Credit : Technical Aspects Governed by IRC Sections 41 and 174
Federal credit is 20% of qualified costs over baseline for activities performed with U.S. Various states have various credit provision for R & D performed within the state and are changing on a continuous basis. Methods of calculation: Traditional Method Alternative Simplified Credit (Fed only) Various State Methods Reduced credit can be elected (IRC 280C); TD 9539 Fed: Can be carried back 1 year and carried forward 20 years; for 2010, carry back is 5 years as ESB credit Carry back and carry forward provision vary by state

The Research and Development Tax Credit

The Four Part Test (IRC 41) The Section 174 Test (IRC 174)
In Connection with a Trade or Business Discover information to Eliminate Uncertainty-Experimental in Nature

New or Improved Business Component Test Process of Experimentation Test Technological in Nature Test

The Research Process: Qualifying Activities

Concept Product or Process

Research and Development Activities Design/Engineering Innovation/Experimentation Prototyping and Testing Foreign Outsourcing Design Fabrication/Prototyping Domestic Outsourcing Design Fabrication/Prototyping

Finished Product or Process

Industries that have qualifying research and development

Adhesives Aerospace Apparel Automotive Agriculture Biomedical Biotech Defense Energy Engineering: Environmental, Civil, Architectural Equipment Financial Services
Food manufacturers/processors

Furniture Healthcare products High Tech Life Science Lubricants Medical Devices Paper Products Software Developers


Research and Development Tax Credit: Qualified Costs Included

Wages, excluding any fringe benefits, of employees directly engaged in the research, or that provide direct supervision or support of the research. This amount can be found on line 1 of the form W-2. Supplies, excluding land and depreciable property. These supplies must be consumed in the performance of the research activities. Certain overhead costs can be included such as rent and utilities and telephone expenses. Outside services incurred during the research process. Only 65% of these costs are eligible for the credit. These costs include outside consultants, software programmers and engineers, outside tool and die makers, etc.

Some Thoughts on Funded Research:

To take the credit, it must not be funded; This involves two concepts:

The business must be at risk on its investment in the research and The business must retain substantial rights in the results of the research

Practical and Regulatory Aspects of Proper Record Keeping


Tier I Internal Revenue Service Issue

R&D Credits have become a Tier I issue with the Large and Mid-Sized Business Division of the IRS There will be more audits with a higher level of scrutiny Agents must adhere to following guidelines now: IRS Industry Directives and Guidelines R&D Audit Technique Guide (Released May 30, 2008) Notice 2002-44 Use of R&D Technical Advisors Four Primary Areas of IRS Concern High-level estimates Biased judgment samples Lack of nexus between the business component and qualified research expenses (QREs) Inadequate contemporaneous documentation


Tier I Internal Revenue Service Issue

Potential remedies to combat the Tier I issue and to document and substantiate credits taken:
Establish Procedures and Tools for Capturing and Maximizing Future Credits Revisit Fixed Base Percentage determination Have researchers/client personnel spend time documenting how they arrived at the R&D percentage qualifications used in determining the qualified research expenses Break out time into appropriate categoriesby person.

Attempt to identify the largest projects that individual cost centers work on. Try to support this determination with work plans, payroll records, etc. Reliance on the recollection of a department head should be your last resort. For documentation, use material originally prepared for non-tax reasons, if you can. Engineers are often pack rats. You might be surprised at the type of details that they retain.

Prequalify Your R&D Costs and Employees

Need to identify which employees are part of the R&D process.
Start with the employees performing R&D services Identify the Not-so-Obvious employees (CEO, Sales persons, Production)

Supplies Outside Contractors


Proper Record Keeping

The ideal methodology to support proper record keeping is:

Contemporaneous Documentation


Research and Development Tax Credit- 2009 2011

A number of important court decisions were handed down in the past 50 months. Here are a few:
Union Carbide v. Commissioner, TC Memo 2009-50 (March 10, 2009) U.S. v. McFerrin, 570 F. 3d 672 (5th Circ June 9, 2009) Trinity Industries, Inc. v. United States, 691 F.Supp.2d 688 (January 29, 2010)

The majority of these decisions were victories for the taxpayer Some of the areas that these cases provided guidance included: Level of documentation Internal Use Software Tests Supplies expense and depreciable items Discovery Test

Sec. 199-Domestic Production Deduction


Basic Deduction Computation

Effective for taxable years beginning after December 31, 2004 Deduction is calculated as follows: 1. 2. 3. 4. 5. Determine Qualified Production Activities Income (QPAI) Compare QPAI to Taxable Income and take the lesser of the two amounts Multiply the lesser amount by the statutory deduction rate (3%, 6% or 9%) Compare this amount to 50% of total annual W-2 Wages The lesser of these two amounts is the allowable Section 199 Deduction


Phase-In of Deduction Rate Taxable Deduction year Rate 2005 2006 2007 2008 2009 2010 and later 3% 3% 6% 6% 6% 9%

Determination of Qualified Production Activities Income (QPAI)

Allocated Domestic Production Gross Receipts (DPGR) Minus Allocable Expenses Cost of goods sold Deductions, expenses, and losses directly allocable Ratable portion of other deductions, expenses and losses Equals QPAI QPAI determined on an item-by-item basis An item may constitute one or more of a finished products component parts, tasks or subtasks that meets all of Code Sec. 199s requirements, even if the entire final product does not satisfy those requirements.


Domestic Production Gross Receipts

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Thank you!