New R&E Expenditure Changes Under IRC Section 174 to Begin in 2022
Jan 26, 2022
As 2022 begins, so does the amendment to the Internal Revenue Code (IRC) Section 174, originally introduced by 2017 tax reform legislation, the Tax and Jobs Act (TCJA.)
That amendment requires both US-Based and non US-Based research and experimental expenditures (R&E) for tax years starting after December 31st, 2021 be capitalized and amortized over a period of five or 15 years, respectively.
Previous to the TCJA amendment, taxpayers could elect to either capitalize and amortize R&E expenditures over a period of at least 60 months, or deduct the expenditures in the year paid or incurred, (taxpayers could also choose to make an election under Section 59(e) to amortize expenditures over 10 years.) Under the new legislation, amortization begins at the midpoint of the taxable year in which expenses are paid or incurred, which could create a significant year-one impact.
For example, if a taxpayer incurs $5 million of R&E expenditures in 2022, the taxpayer will now be entitled to amortization expense of $500,000 in 2022. We arrived at this calculated by dividing $5 million by five years, then cutting the annual amortization amount in half. Prior to the TCJA, the taxpayer would have immediately expensed all $5 million on its 2022 tax return, assuming it did not make an election under Section 174(b) or Section 59(e) to capitalize the amounts.
Additionally, software development costs have been added as R&E expenditures under Section 174(c)(3) and, therefore, are also subject to the same mandatory amortization period of five or 15 years. Previously, under Rev. Proc. 2000-50 options existed for taxpayers to either expense software development costs as they incurred, amortize over 36 months from the date the software was placed in service, or amortize over not less than 60 months from the date the development was completed.
Immediate Considerations
Under the new Section 174 requirements, taxpayers should ensure that all R&E expenditures are properly identified, as some may be able to leverage from existing systems/tracking to identify R&E. Taxpayers that have existing systems in place to calculate the research credit will likely be able to use such computations as a helpful starting point for determining R&E expenditures. By definition, any costs included in the research credit calculation would then need to be recovered under the five-year amortization period.
Taxpayers currently not identifying any R&E expenditures should consider the steps necessary to assess the amount of their expenditures that are subject to Section 174. Under some circumstances, it may be wise to begin separating out R&E expenditure amounts to their own trial balance accounts, e.g. to have a separate “trial balance account” for R&E expenditure wages versus non-R&E wages. Determining which costs should be included in the relevant R&E expenditure trial balance accounts will likely involve interviews with the taxpayer’s operation and financial accounting personnel, as well as the development of allocation methodologies that determine which expenses (e.g., rent) relate to both R&E expenditure and non-R&E expenditure activities.
Additional Effects of Section 174 Amendment
It should be noted that under Section 174, the types of expenses eligible for duction are generally broader than those expenses eligible for credit under Section 41. For example, Section 41 allows supplies, wages and contract research, while Section 174 can include items such as utilities, depreciation, attorneys’ fees and other expenditures related to the development or improvement of a product.
Key Take-Aways
The implemented changes of Section 174 may bring some potentially favorable tax developments for those previously employing the capitalization of R&E expenditures. With the new amendment allowing for amortization of R&E expenditures at the midpoint of the fiscal year they were incurred, certain taxpayers may be able to recoup those costs sooner.
It should also be noted that the language in the TCJA indicates that the Section 174 amendment should be treated as a “change in method of accounting” and applies on a cut-off basis beginning for tax year 2022. Any costs incurred before 2022 will remain as-is and fall under the previous rules mentioned above. It is still unknown if taxpayers that previously expensed their R&E expenditures will have to file an “Application for Change in Method of Accounting (Form 3115).”
The IRS is expected to release guidance on how taxpayers should comply with the new rule for the 2022 tax year, presuming the start-date of the provision is not again postponed by Congress. Because of this and other areas of uncertainly surrounding the new amendment, taxpayers should continue to monitor IRS and Treasury updates, or consult with their William Vaughan advisor before filing any 2022 tax returns in order to ensure compliance with the latest regulations.
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Robert Bradshaw, CPA
Tax Partner
bob.bradshaw@wvco.com | 419.891.1040
Categories: Tax Planning
Canada’s New Digital Sales Tax
Jan 10, 2022
Written by: Brian Morcombe, Partner & Indirect Tax Practice Leader, BDO Canada – 2021
On July 1, 2021, new rules came into force that will significantly impact non-resident vendors and online platform operators. Specifically, the changes require certain non-resident vendors and operators of online platforms to register for, collect, and remit goods and services tax (GST)/harmonized sales tax (HST) on:
- sales of digital products and services provided to Canadian customers;
- goods supplied through fulfillment warehouses located in Canada and made by non-resident vendors directly through websites; and
- supplies made via short-term accommodation platforms.
Here’s what you need to know about Canada’s new digital sales taxes.
Supplies of digital property and services
What are the new rules?
Non-resident vendors supplying digital property and services to consumers in Canada are required to register for and collect GST/HST on these taxable supplies to Canadian consumers. An example is Netflix which, prior to July 2021, may not have been viewed as carrying on business in Canada and was not required to register for GST/HST. Under the new rules, Netflix is required to register to collect tax from customers in Canada that are not registered for GST/HST, putting Netflix on equal footing with Canadian resident streaming service vendors already required to collect tax from customers.
A consumer includes persons not registered for GST/HST (persons registered for GST/HST are not considered consumers for the purposes of the new rules). Operators of third-party distribution platforms making these types of supplies are also required to register. A simplified registration and remittance framework is available to these registrants that are not otherwise carrying on business in Canada.
The new requirements apply to non-resident vendors and distribution platform operators whose revenue from taxable supplies of property and/or services exceed, or are expected to exceed, C$30,000 over a 12-month period.
Can ITCs be claimed?
A condition of the simplified framework is that non-resident vendors and distribution platform operators using the simplified registration framework are not able to claim input tax credits (ITCs) to recover any GST/HST paid on expenses they incur related to their Canadian sales.
Goods supplied through fulfillment warehouses and through websites
What are the new rules?
Distribution platform operators are required to register to collect and remit GST/HST under the general regime (as opposed to the simplified framework discussed above) on sales of goods located in warehouses in Canada if the sales are made through that platform by non-registered vendors. Non-resident vendors using Canadian fulfillment warehouses to sell in Canada without the use of a distribution platform are also required to register for and collect GST/HST under the general regime. Fulfillment businesses in Canada are required to notify the Canada Revenue Agency of their activities and maintain certain records related to non-resident clients.
Lastly, non-resident vendors that make sales to consumers in Canada using their own website are generally also required to register for GST/HST under the general regime. GST/HST registration and collection is required where qualifying supplies, including those made through distribution platforms by non-registered third-party vendors to purchasers in Canada that are not registered for the GST/HST, exceed or are expected to exceed C$30,000 in a 12-month period.
Can ITCs be claimed?
Vendors that are registered under the general regime, as opposed to the simplified framework, will generally be eligible to claim ITCs in respect of GST/HST incurred in the course of their commercial activities.
Short-term accommodation platforms
What are the new rules?
GST/HST applies to all supplies of short-term accommodation (generally a residential complex or unit supplied for periods of less than 30 days and for more than C$20/day) supplied in Canada through an accommodation platform, such as Airbnb. If the property owner is registered for GST/HST, the owner continues to be responsible for collecting and remitting the GST/HST from its guests. If the property owner is not registered for GST/HST, the accommodation platform operator must collect and remit the GST/HST on that property owner’s supplies of accommodation to consumers.
Can ITCs be claimed?
Non-resident accommodation platform operators that are not considered to be carrying on business in Canada and are making supplies to consumers (as opposed to GST/HST registered persons) use the simplified registration framework, resulting in no entitlement for ITCs. Accommodation platform operators that are resident in Canada are required to register under the general regime and are able to claim ITCs where all conditions are met.
What about provincial sales tax (PST)?
If all of this sounds familiar, it should. Quebec introduced digital sales tax provisions aimed at non-residents of Canada that are not registered for GST/HST and Quebec sales tax (QST), defined as foreign specified suppliers, as well as specified digital platform operators on Jan. 1, 2019, requiring them to become registered for QST. Beginning Sept. 1, 2019, this QST registration requirement was broadened to include residents and non-residents that are registered for GST/HST but not registered for QST (i.e., Canadian specified suppliers).
Impacted vendors are required to register for QST under the simplified framework where sales exceed C$30,000 to individual consumers in Quebec in the preceding 12 months and relate to intangibles (like software and digitized products) and services. Canadian specified suppliers are required to collect QST on goods as well as intangibles and services. Like the new GST/HST simplified framework, Quebec restricted input tax refunds on vendors using its simplified framework.
Effective Jan. 1, 2020, Saskatchewan introduced rules targeting non-residents making e-commerce sales to purchasers in the province. Online marketplace facilitators and online accommodation platforms are now required to register and collect PST on electronic distribution services that are delivered, streamed, or accessed through an electronic distribution platform (e.g., website, internet, portal, or gateway) and online accommodation services that are delivered or accessed through an online accommodation platform, respectively.
British Columbia expanded its PST registration requirements to include Canadian sellers of goods, along with Canadian and foreign sellers of software and telecommunication services. These new provisions come into force on April 1, 2021.
Lastly, Manitoba recently released legislation taxing certain digital sales of goods and services effective Dec. 1, 2021. The following vendors will be caught in the new rules and will be required to register for, collect and remit Manitoba retail sales tax (RST):
- online marketplaces on the sale of taxable goods sold by third parties via their online platforms;
- online accommodation platforms on the booking of taxable accommodations in Manitoba; and
- audio and video streaming service providers on the sale of streaming services (by virtue of being included as telecommunication services).
Given the different approaches taken by the federal government and each of the provinces when taxing digital property and services, vendors and platform operators will need to gain a strong understanding of the requirements in each jurisdiction to prevent costly errors. If you need assistance navigating these rules, please contact your WVC advisor
Categories: Uncategorized
Funding For Import-Challenged Ohio Manufacturers – Up To $75,000
Jan 03, 2022
Have your sales been hit by import competition? If so, the federal Trade Adjustment Assistance for Firms (TAAF) program may be able to help. For Ohio manufacturers, the program is managed by the Great Lakes Trade Adjustment Assistance Center (GLTAAC) who helps qualified manufacturers identify, develop, staff, and pay for critical business improvement projects. GLTAAC clients have received up to $75,000 in matching funds.
While TAAF matching funds are extremely beneficial, GLTAAC clients also value the planning assistance received from their experienced team of manufacturing professionals. The guidance helps to clarify which projects can best support each client’s growth strategy while matching funds help clients fast-track those important efforts – regardless of the project’s size. Here are just a few case studies to demonstrate the value of GLTAAC and how leveraging funding can aid your organization:
- Big impact from a quick and concentrated effort for an instrumentation manufacturer – An Ohio GLTAAC client had recently changed its name and required a rebrand with a new logo. After multiple conversations with key company stakeholders and a marketing consultant, a new logo was developed. The company’s website now features their re-designed logo and the GLTAAC client states, “This TAAF co-funded project was a simple, small – but strategic – marketing effort. Two weeks of intense work and results.”
- TAAF matching funds saved both money and time for Ohio foundry – When their existing ERP system was being phased out, this GLTAAC client knew they would use TAAF matching funds for outside IT expertise to migrate to a new system. However, they also recognized their shortage of a key resource: time. They elected to utilize TAAF co-funding to hire a consultant to serve as the internal project manager for the entire ERP upgrade process. The consultants managed and ran all aspects of the upgrade, which enabled the project to be completd on schedule without disruption. Total cost for both consultants: $91,000 (TAAF paid 50%).
If import competition has hurt your sales, don’t put off learning more about TAAF and GLTAAC. Here’s how to get started.
STEP ONE – Contact GLTAAC Project Manager, Jani Hatchett at hatchett@umich.edu or 734.998.6227. Jani can quickly outline the TAAF program and help you determine whether your firm would qualify and provide the next steps.
STEP TWO – Don’t forget to follow us on LinkedIn and check out our website at www.gltaac.org.
Categories: Manufacturing & Distribution
Ohio’s Municipal Withholding Dilemma – Take 3
Dec 30, 2021
Hybrid work arrangements significantly impact municipal income tax withholding requirements and raise other municipal tax issues.
With the start of the new year just around the corner, the “pre-pandemic” law for Ohio municipal income tax withholding will soon return.
Applicable to periods beginning on or after 1/1/2022, if an employee works a hybrid schedule by spending some days working at home and other days working at the office, employers will once again be required to withhold municipal tax based on where the employee’s work is actually performed. For many employers, this may trigger withholding for employees’ home municipalities that the employer may never have been required to do before. Additionally troubling is the requirement for businesses to allocate such wages, and potentially apportion some gross receipts (sales) as well, to these home municipalities for purposes of the net profits (income) tax, subjecting the company to income tax reporting in each of their employees’ home municipalities.
As we recommended in our July blog, to ease the complexities of tracking actual work locations for Ohio municipal withholding requirements in 2022, employers could consider having employees sign formalized, hybrid work agreements. Such agreements provide consistency, structure, and ease of record keeping. In exchange for permitting hybrid work schedules, employers might consider requiring employees to report true-up differences between actual and forecasted work on their personal municipal income tax returns and to provide proof of payment (in case the employer is audited). Noting that the hybrid work agreement will be helpful but cannot cover all municipal activity, employers could also aim to develop ways within their internal system to most easily track multi-location work performed by employees throughout the year. Employers could consider contacting municipalities to gain pre-approval of estimated or hybrid withholding approaches or enter into withholding agreement(s) with the municipalities. Consultation with legal counsel related to any employment arrangements should also be considered due to the complexity of labor laws.
If we can assist you regarding your specific facts and circumstances and in making decisions about municipal income tax compliance or if you have any questions, please contact your William Vaughan Company advisor.
Categories: Tax Compliance
Employee Retention Tax Credit – Updates & Reminders
Nov 15, 2021
Don’t leave ERTC money on the table!
The Employee Retention Tax Credit (ERTC) is a provision established under the CARES Act which has been enhanced by additional legislation and could provide an immense amount of capital to employers. Unfortunately, statistics are showing the credit is being underutilized. The good news is with year-end planning on the horizon, now is the perfect time to leverage the ERTC.
What is the ERTC?
This is a refundable tax credit employers can claim against certain employment taxes, equal to a percentage of qualified wages and health insurance premiums paid after March 12, 2020, and before September 30, 2021.
For 2020, the credit is 50% of qualified payments, up to $10,000 per employee. Simply put, an eligible business has the potential to request refunds of up to $5,000 per employee for the year.
For 2021, the credit increases to 70% of qualified payments, up to $10,000 per employee per quarter. The credit was intended to run through December 31, 2021, but the passing of the recent Infrastructure Bill put an end to it after September 30. Nevertheless, the credit is still fair game for the first three quarters of 2021. With a maximum credit of $7,000 per employee, per quarter, a business eligible for all three quarters of 2021, could receive refunds of $21,000 per employee. Without question, the ERTC can provide much-needed dollars for eligible employers.
How do I know if my business is eligible?
For most businesses, eligibility is determined by meeting one of two tests; with a third test available for quarters 3 and 4 of 2021, which will be outlined later.
- TEST #1 – A measure of decline in gross receipts. If an employer experiences a significant decline in gross receipts for any calendar quarter, as compared to the same calendar quarter in 2019, they will be eligible for the credit in that quarter. For 2020, this is defined as gross receipts that are less than 50% of gross receipts for the same quarter in 2019, and for 2021, this is gross receipts being less than 80% of gross receipts for the same quarter in 2019.
- TEST #2 – A full or partial suspension of operations. If an employer was subject to any full or partial suspension of operations because of government orders related to COVID-19 they could be eligible. These orders could be Federal, State, county, and/or municipality. Even if your business was deemed essential and was not directly affected by such orders, there still could be avenues to be eligible for the credit.
- TEST #3 – Under a third test, if a business can meet the definition of a recovery startup business, they can claim the credits for the 3rd and 4th quarters of 2021 only (not exceeding $50,000 per quarter). A recovery startup business is any employer that began a trade or business after February 15, 2020, and has average annual gross receipts of less than $1,000,000.
What are some important details to keep in mind?
- First, gross receipts are determined based on the method used for the employer’s tax return. Meaning, if your business uses the cash method for tax purposes, then gross receipts for Test #1 should be calculated using the cash method, even if your financial statements use the accrual method. This could be beneficial for businesses, especially during times when the pandemic was hitting the hardest and collections slowed.
- Another important item to keep in mind is that, for this credit, employers are considered either small or large. For 2020, a small employer is one that, based on 2019 counts, averaged 100 or fewer full-time employees. For 2021, this number increases to an average of 500 or fewer full-time employees, still based on 2019 counts. If a business is above these amounts, they are considered large. Small employer status is more advantageous because it allows qualified wages to include all wages paid. If a business is considered a large employer, qualified wages are limited to wages paid to an employee only for the time that employee was not providing services. For example, if your business is a large employer and operations were partially suspended, but all your employees continued working during that time, your business may not be able to claim any credits on the wages paid during that suspension period. For this purpose, a full-time employee is an employee that, in 2019, averaged at least 30 hours per week or 130 hours per month. As an example, an employer in 2019 who had 5 employees that worked 25 hours per week and 5 employees that worked 30 hours a week, would only be considered to have 5 full-time employees. Early on, a common misconception was that full-time employees were equal to full-time equivalents, which may have caused some businesses to think they were large employers, when in fact that may not be the case.
- Finally, there are several different paths a business could take to qualify for the ERTC based on a full or partial suspension of operations due to governmental orders. As previously mentioned, even if your business was not directly affected by the orders, there still could be ways to qualify for the credit. We encourage you not to overlook this test as it could be very beneficial to revisit.
What are my next steps?
With year-end planning season looming, your William Vaughan Company advisor will surely be discussing this topic with you in the coming weeks. If you are not currently a client, but this topic has piqued your interest and you would like us to look at how this credit might benefit your business, please do not hesitate to reach out to us. As mentioned, the credit has been generally underutilized, so we would love to help your business realize the greatest benefits it can.
Connect With Us.
Mike Hanf, CPA, CGMA
ERTC Lead
mike.hanf@wvco.com
Categories: Tax Planning