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Thursday, January 5, 2017

Three Tax Incentives to Consider in 2017

The federal tax code can be a lot like the accounting version of a treasure map. Buried within its many pages is an ever-changing array of tax provisions that can yield significant benefits, if you know where to look and how to plan for them. As you chart your compliance strategy for 2017, here are some underutilized tax incentives to consider.

IC-DISCs Offer Tax Deferral on Exports
For a high-tech company or other manufacturer doing business overseas, interest charge domestic international sales corporations (IC-DISCs) can be a very beneficial tool. Meant to promote foreign trade, these versatile entities can provide manufacturers with long-term deferral of the tax on export profits. (Note that California state rules do not conform to the federal tax code for this.)

IC-DISCs typically are set up to take advantage of favorable U.S. tax rates on dividend distributions, or to direct a steady flow of cash distributions to a specific group of shareholders. Export-related income is accumulated within the IC-DISC as commissions, and taxes are deferred until the funds are distributed. You get an ordinary income tax deduction for the payment of the commissions, but the distributions are taxed at a lower rate as qualified distribution income.  

The structures can be used with S-corporations or C-corporations, and can yield some significant savings. For example, a pass-through entity that has $10 million in annual export sales and $1 million in export profits, and pays $500,000 a year in dividends, could save almost $80,000 in federal taxes by paying those dividends into an IC-DISC. Commissions can be calculated on a transaction-by-transaction basis as either 4% of export receipts or 50% of export profits, and transactions can be excluded, which gives you a lot of flexibility.

The requirements for setting up an IC-DISC include the following: At least 95% of the entity’s assets must be qualified export assets, and at least 95% of its gross receipts must be qualified export receipts (this does not mean that your company must export 95% of its sales). To qualify as export property, the exported product must be manufactured in the U.S., and no more than half of its value can be attributed to imported materials.  

Although IC-DISCs have been around for decades, we see surprisingly few companies taking advantage of them. But as trade becomes increasingly global, the structures will be useful for more and more manufacturers. Over the next few years, we may also see the government tweak the rules to make IC-DISCs even better for U.S. exporters.

R&D Credits Have Some New Advantages
If you run a small business or a software firm, you may want to take a fresh look at research and development (R&D) credits, thanks to some recent rules that make them more advantageous.

Small businesses may be able to use two new offsets, for the alternative minimum tax (AMT) and payroll tax. Eligible partnerships, sole proprietorships and privately held companies can now claim the R&D credit against their AMT liabilities, as long as their average annual revenue for the prior three years doesn’t exceed $50 million. Companies with annual gross receipts of less than $5 million can now use R&D credits to offset up to $250,000 of payroll tax, as well.

R&D credits for internal use software (IUS) have also had some changes. In October, the IRS published its final rules on R&D credits for IUS, which retain many of the favorable elements of the proposed regulations. In general, the final rules narrow the definition of IUS and expand the opportunities to claim credit for software development.

If you haven’t used the R&D credit for a long time, you also may have opportunities to go back as far as 10 years and take the credits you didn’t or couldn’t use before. For example, one of our technology clients recently calculated several years’ worth of R&D incentives for the first time, uncovering almost $1 million of useable credits.

QSBS Benefits Individual Investors
The qualified small business stock (QSBS) provision is an underused incentive for individual taxpayers. It has been around a long time, but until recently it was subject to an AMT preference item, which limited its appeal. Rule changes a few years ago eliminated that preference item, however, so QSBS has become a very intriguing option for the owners of stock in certain types of small companies, including technology firms. (Again, California does not conform to the federal treatment.)

The QSBS rules allow you to exclude as much as 100% of the gains on the sale of qualified shares, up to the greater of $10 million or 10 times your adjusted basis in the stock. You must have held the stock for five years, and it must meet these requirements:

  • The stock must be in a domestic C-corporation.
  • At least 80% of the value of the corporation’s assets must be used in the active conduct of one or more qualified businesses. Generally, this means producer-type companies. Professional services firms do not qualify. 
  • The corporation can’t have more than $50 million in assets on the date the stock was issued and immediately after.
  • The stock must be acquired at its original issue, not from a secondary market.

There is also a very beneficial rollover provision, which allows you to sell stock you’ve held for at least six months and replace it with other QSBS within 60 days, without paying current tax on the gain. The rollover also keeps the clock ticking on your holding period. You can use this provision to spread your risk among stocks in multiple small corporations.

These are just a few of the tax code provisions to consider as you plan for the coming year. To learn more about them, as well as other tax-saving opportunities, contact your local Armanino tax professional.


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