Generally, the IRS has three years from the later of the original due date or the date on which the taxpayer files their return to assert that the taxpayer owes additional tax. After that, except under unusual circumstances, the IRS is precluded from collecting additional tax for that year. One of those unusual circumstances is a gross omission of income. The IRS has maintained for many years that an understatement of basis can result in a gross omission of income.

To illustrate the IRS position, assume that John Smith claims that stock he sold for $100,000 had a basis of $75,000. He therefore reports a gain of $25,000 on its sale in determining his taxable income for the year. However, his actual basis in the stock was only $10,000. Thus, a gain of $90,000 should have been reported on the stock sale. If John’s only other income was his $100,000 salary, then the IRS would take the position that John has a gross understatement of income because he had underreported his income by $65,000 ($90,000 minus $25,000), which is more than 25 percent of John’s gross income. Therefore, according to the IRS, a six-year statute of limitations would apply.

The Supreme Court in Home Concrete, resolving conflicts between different Circuit Courts of Appeal, said that the law on this issue was clear. The law specifically states that there must be a gross omission of income. If all of the taxpayer’s income has been reported, there can be no gross omission of income. There may be an underreporting of taxable income, but the statute only refers to an omission of income. Thus, in the example above, John reported all of his income (i.e., the $100,000 gross sales proceeds plus his $100,000 salary) so there was no gross omission of income. A three-year statute would apply to his return, assuming there is no fraud involved. (The statute of limitations never expires on a fraudulent return.)

While the Supreme Court’s decision in this case is good news for taxpayers, it is bad news for the IRS on another issue, which may be of far greater significance. The IRS takes the position that if Treasury issues regulations on a tax issue, the position stated in the regulations is presumptively correct.

Regulations explain and interpret tax laws. This is important and helpful, particularly when the law is not perfectly clear. Generally, the courts have given such regulations deference, meaning that unless the regulations are clearly wrong, they are presumed to correctly explain the law and its application to particular facts and circumstances. This deference has played a major role in helping the IRS successfully litigate tax issues in the courts.

In this instance, however, the IRS issued regulations in December 2010 on the basis overstatement issue at the same time it was litigating the issue in the courts. The courts were more than a little uncomfortable with this as the IRS could, in effect, rewrite the law while a case is being considered by the courts. Justice Scalia, in his concurring opinion, expressed concern about the mischief that could be created by giving an agency the power to change a trial court decision by regulation.

The Home Concrete case blurs the extent to which the courts will or should give deference to IRS regulations in the future. Taxpayers should find it comforting to know that if the statute is clear, Treasury will not be able issue regulations supporting the IRS position and assume that those regulations will be presumptively correct.

Your CB&H tax advisor would be pleased to discuss this case with you and clarify its implications for taxpayers.

Recognizing that convergence will take more time, the European Commission (the European Union’s executive body) recently extended rules that permit European Union–listed U.S. companies to continue to use U.S. GAAP. The rules had expired at the end of 2011, but the European Commission granted a three-year extension, retroactive to January 1, 2012.

FASB and IASB Standards
FASB and IASB have completed several short-term convergence projects, substantially converging their standards for share-based payments, segment reporting, the fair value option for financial assets and liabilities, borrowing costs, and more. In some cases, such as share-based payments, both boards issued revised standards. In others, convergence required one board to revise its standards to align with those of the other board.

The boards currently are working on four high-priority convergence projects:

1. Revenue recognition
2. Leasing
3. Financial instruments
4. Insurance contracts

As of this writing, the boards are close to reaching an agreement on revenue recognition but continue to deliberate over the other three projects. In an April 20th update submitted to the Group of 20 industrial nations, FASB and IASB said they expect to begin redeliberations of their joint project on revenue recognition shortly and to re-expose aspects of their financial instrument project, as well as their projects on leases and insurance, in the second half of 2012. The boards expect to issue final standards on these projects by mid-2013 (about two years behind their original schedule).

SEC Adoption of IFRS
While FASB and IASB have been striving to converge their standards, the U.S. Securities and Exchange Commission (SEC) has been exploring the possibility of adopting IFRS for use in the United States. In 2007, it eliminated the requirement that foreign registrants that use IFRS reconcile their financial statements to U.S. GAAP. Then, in 2008, the SEC issued its proposed “roadmap” to adoption of IFRS by U.S. companies.

The SEC had planned to vote in 2011 on whether to make IFRS mandatory for U.S. public companies beginning as early as 2015, but the decision was pushed back until 2012. In February 2012, an SEC staff member said that a decision on IFRS was “a few months away.”

Condorsement the Way Forward?
In May 2011, the SEC published a paper suggesting condorsement — a combination of convergence and endorsement — as a possible alternative to requiring U.S. companies to adopt IFRS outright.

Under this approach, FASB and IASB would continue their efforts to converge U.S. GAAP and IFRS. At the same time, FASB would endorse and incorporate other IFRS standards into U.S. GAAP individually over time.

The Financial Accounting Foundation (FAF) – FASB’s parent organization –  proposed that FASB and IASB complete the four high-priority convergence projects discussed above. Then, rather than adopt IFRS, the United States would retain U.S. GAAP but defer to IASB to set new accounting standards (although FASB would actively participate in the process). FASB would retain the authority to develop its own standards in critical areas in the event IASB fails to provide satisfactory guidance or fails to address an issue in a timely fashion.

FASB and IASB leaders emphasized that, for this approach to work, the threshold for deviating from IFRS must be high. If there are too many “nonendorsements” or FASB creates too many “carve-outs” that depart from IASB standards, the benefits of uniform global accounting standards will be lost.

The SEC staff has hinted that its upcoming report on IFRS will recommend an endorsement framework that combines a strong U.S. commitment to international accounting standards while preserving FASB’s role in the standard-setting process.

More Clarity in Coming Months
Just about everyone agrees that a single set of high-quality global accounting standards is a worthy goal. Uniform standards would improve comparability for both domestic and cross-border financial reporting, enhance transparency, facilitate capital raising and reduce accounting complexity and expense. The challenge is finding a way to achieve that goal with minimal disruption to U.S. markets and without diluting the authority of the SEC and FASB over U.S. accounting matters.

Tax Changes for Individuals

Tax Exemptions Increase for Married Filers
Beginning 2013, married taxpayers filing jointly will receive an exemption of $7,400, a marked increase of the current $5,400 exemption. Those married filing separately will be entitled to an exemption of $3,700. The personal exemption for unmarried individuals remains unchanged at $2,700.

Motor Vehicle Property Tax Phased Out
Vehicles purchased and titled after March 1, 2013 will no longer fall under existing sales and annual property tax regulations. Instead, owners will pay a one-time fee equal to seven percent of fair-market value less trade-in value. The rate is phased in over three years beginning with 6.5% in 2013, 6.75% in 2014 and the full 7% in 2015 and every year thereafter. Individuals purchasing a vehicle between January 1, 2012 and March 1, 2013 may elect either the annual tax or new one-time fee system. Any owner of a vehicle titled before January 1, 2012 will continue to pay annual state taxes as normal.

Retirement Income Exclusion Capped
Beginning 2013, any taxpayer of ages 62-64, or those who are totally disabled, may exclude up to $35,000 of retirement income per year. Taxpayers 65 and older may exclude up to $65,000 of retirement income per year. Qualified retirement income includes interest, dividends, capital gains, pension income, and up to $4,000 of earned income.

Tax Changes for Businesses

Amazon Tax Added
The Legislature added a click-through nexus provision, also known as an “Amazon tax.” Covered dealers now include any person entering into a sales agreement with a Georgia resident, whether online or in-person, if gross receipt sales exceed $50,000 in a 12-month period.

Manufacturing and Agriculture Exceptions Altered
Phased in over a four-year period, manufacturers will now be exempt from sales and use tax on energy used in manufacturing tangible personal property.

The Legislature repealed many sales and use tax exemptions for manufacturing, agriculture, poultry and timber. Some exemptions still remain for businesses such as packaging supplies, energy used in agriculture, and certain agricultural machinery and equipment.

Sales and Use Tax Nexus Altered
An out-of-state business will now be considered to have nexus with Georgia if it makes taxable sales and a related member has substantial nexus with Georgia. This could include a business with a similar line of products and the same or similar name, or a business using trademarks or trade names substantially similar to those used by a business having nexus with Georgia.

If you have any questions about changes to your individual or business taxation under these new rules, contact your local tax professional immediately.

Crowdfunding from Non-Accredited Investors

The JOBS Act eases restrictions on equity-based crowdfunding to now allow investments by all investors, not just accredited investors. Any non-credited investor can invest up to the lesser of 10 percent of annual income or $10,000. Crowdfunding investments will still need to file with the Securities and Exchange Commission (SEC), and are restricted to raising $1 million annually, or $2 million if they have filed audited financial statements.

Crowdfunded companies will need to provide the SEC with names of directors, officers and any shareholder with more than 20 percent of the company’s stock, as well as a business description and the following financial information:

• If raising less than $100,000, then financial statements must be certified by a company principle
• If raising between $100,000 and $500,000, then financial statements must be certified by a CPA
• If raising $500,000 or more, then financial statements must be audited by a CPA

More Growth Allowed Prior to SEC Registration

The JOBS Act raises the Regulation A threshold from $5 million to $50 million in a 12-month period before having to register with the SEC. This will likely be of great use to angel-funded ventures.

The JOBS Act also expands the limits currently set for registration with the SEC. Currently, a company must register once it reaches 500 investors and total assets of $10 million. The new law increases those limits to 2,000 investors or 500 non-accredited investors and $10 million in total assets. Companies will have 120 days of the first fiscal year in which they exceed these caps to register. There is no specific deadline for implementation of this provision.

Easier Path to Going Public

Effective immediately, the JOBS Act adds an SEC stock issuer category called “emerging growth company.” An emerging growth company is defined as having less than $1 billion in gross revenues in its previous fiscal year and less than $700 million in publicly traded shares after an IPO. These companies will receive a five-year exemption from some SOX 404(b) requirements, such as hiring outside auditors. If you have filed for an IPO since December 8, 2011, you may retroactively apply for “emerging growth company” status.

Greater Ability to Attract Accredited Investors

The Act removes the SEC ban on advertising Regulation D 506 stock offerings to attract accredited investors to a non-public offering.

These new provisions are likely to drastically shift reporting compliance requirements while opening more sources of funding for entrepreneurs. If you have any questions as to what opportunities may exist for you and your business under the JOBS Act, contact your local CB&H advisor.

On March 15, 2012, IRS issued a Directive for field examinations on the repair vs. capitalization issue that essentially suspended current examinations. For examinations of tax years beginning before January 1, 2012, examiners are instructed to discontinue current exam activity and not begin any new activity with regard to the “issues,” which are defined as:

• Whether costs incurred to maintain, replace, or improve tangible property must be capitalized under Sec. 263(a); and
• Any correlative issues involving the disposition of structural components of a building or dispositions of tangible depreciable assets (other than a building or its structural components).

In connection with such examinations, examiners are directed to withdraw: 1) the portions of any Information Document Requests that relate to these capitalization issues; and 2) all Notices of Proposed Adjustments related to these issues. Any existing Notice is to be replaced with a new Form 5701 and Form 886-A, Explanation of Adjustments. The Directive specifies that language be included to indicate that the IRS does not accept or reject the position the taxpayer took on its return on these issues, and that the taxpayer has two years to adopt the appropriate method of accounting under newly issued revenue procedures. All of this must be documented in the examination file.

Initially, this may appear to be good news, but it indicates that the IRS is going to be aggressively pursuing enforcement of its new capitalization rules. Fortunately the IRS also issued detailed guidance in the form of two new Revenue Procedures (Rev. Proc. 2012-19 and Rev. Proc. 2012-20) which provide transition rules that taxpayers must follow to comply with the temporary regulations.

Businesses should take action now in order to ensure compliance with the new temporary regulations, and to take advantage of some of the opportunities these regulations afford.

CB&H will continue to monitor developments on this issue, and we will be providing specific guidance on these new regulations and related guidance in the near future. In the meantime, please do not hesitate to contact your CB&H tax advisor if you have any questions or concerns about how these new regulations apply to your business.

Change was deemed necessary because the existing rules were confusing and caused many unintentional errors in financial statements. But the proposal, under which the previously far-flung guidance on the topic would be melded into a single tidy package, hasn’t cleared up much confusion.

The first exposure brief on the matter, in late 2010, generated nearly 1,000 comment letters. “It was one of the most hotly debated exposure drafts in quite some time,” says Robert Bedwell, a partner at accounting firm Cherry, Bekaert & Holland.

In response to the debate, the Financial Accounting Standards Board and International Accounting Standards Board issued a second exposure draft this past November. So far, formal reaction has been tepid relative to the earlier document. By press time, the boards had received just 18 comment letters, most of which asked for more time to provide feedback. Comments are due by March 13, and most likely more letters will be sent in as that date nears.

Despite the small number of comments, FASB and the IASB are moving ahead with their plan for what amounts to a grassroots campaign to address any remaining misgivings about the proposed new standard, called “Revenue from Contracts with Customers.” The boards have been trying to finalize a converged revenue-recognition standard for four years and clearly don’t want to waste any more time.

Click here to read the article.

Each individual has a basic exclusion amount, and that amount can be transferred free of federal gift and estate taxes. The basic exclusion amount in 2011 was $5 million and, adjusted for inflation, the 2012 basic exclusion amount is $5.12 million. Under the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010, individuals now have the opportunity to later use the remaining amount from a deceased spouse’s unused exclusion amount (DSUEA), in addition to their own exclusion when making gifts and upon death.

The ability to transfer the DSUEA to the surviving spouse is referred to as “portability.” Portability applies only to married decedents in 2011 and 2012. Under current law, portability will not be available for use by a surviving spouse after 2012. A recommendation to make the law permanent was included in President Obama’s proposed fiscal year 2013 budget.

The following example describes how portability might benefit a surviving spouse:

Assume that an individual’s husband died in 2011, having made no taxable gifts and having a $3 million taxable estate. The husband’s estate files the estate tax return, which permits his wife to use his DSUEA. As of her husband’s death, the wife has made no taxable gifts. Thereafter, she does not have to pay taxes on the first $7 million of her assets (her $5 million basic exclusion amount plus $2 million DSUEA from her husband), which she may use for lifetime gifts or for transfers at death.

The DSUEA is available to a surviving spouse only if an election is made by the deceased spouse’s executor on a timely filed estate tax return (Form 706). Generally, the executor must file a Form 706 within nine months of the decedent’s death, plus any applicable extensions. Estates are entitled to an automatic six-month extension to file if a Form 4768 is filed on or before the original Form 706 due date.

Because of the late release of the 2011 Form 706 and related instructions, public and professional practitioners had concerns over the specifics of the new portability rules. In response to those concerns, the IRS issued Notice 2012-21 (the Notice), which provides certain estates with the ability to obtain a retroactive extension to file Form 706 to preserve portability.

Pursuant to the Notice, the IRS grants the executor of a “qualifying estate” a six-month extension (until 15 months after the deceased spouse’s date of death) to file a Form 706. The Notice generally defines a qualifying estate as the estate of a decedent:

• whose date of death is after December 31, 2010, and before July 1, 2011;
• who is survived by a spouse; and
• whose gross estate does not exceed the $5,000,000 basic exclusion amount for 2011.

Filing an estate tax return and making the DSUEA election is not an easy decision. There are many items to consider, including:

• Age of the surviving spouse – the younger a surviving spouse, the more time there is for the survivor’s estate to grow
• Size of the survivor’s estate and potential for growth
• Potential of survivor’s estate to increase because of gifts, inheritance, and unexpected growth in inherited assets
• Potential generational skipping possibilities in estate plans
• Fees required to be paid for the preparation of the estate tax return (which is not otherwise required to be filed)

An executor making the DSUEA election may incur a cost with little downside to a fiduciary’s preservation of the DSUEA, particularly because it is the only way to maximize a married couple’s estate tax exclusion amount in certain circumstances. However, if an executor fails to make an election to preserve the DSUEA, that fiduciary may have an unforeseen liability. Notice 2012-21 gives executors of qualifying estates an extended or second chance to preserve the DSUEA.

Executors should seriously consider taking advantage of the relief offered by the IRS by filing a Form 4768 to maximize the time available to file a Form 706.

FOR MORE INFORMATION, PLEASE CONTACT:

Mike Kirkman | bio
Director of Estate & Trust Tax Services
800.849.4224
mkirkman@cbh.com

Moreover, since the enactment of the American Jobs Creation Act of 2004¹, taxpayers can also take advantage of the 15-percent capital gains rate on dividend distributions, which provides a permanent tax benefit of 20 percentage points compared to the highest individual tax rate, and up to 35 percent if the exporter is a dividend-paying C corporation.

Taxpayers could save as much as 35 percent on net income from export transactions. For example, if the export sales of a C corporation are $1 million and the profit percentage² is 40 percent, export profits are $300,000. Combined taxable income (CTI)³ is $200,000 and federal tax savings alone will be at least $70,000. Usually profits from export transactions are significantly higher than from domestic sales.

Why is this tax benefit so underutilized? In my opinion, the reasons range from lack of integration of federal government resources for exporters to complicated technical aspects requiring specialization on the part of tax advisors. I recently attended an export summit in Richmond, Va., that aimed to educate exporters about the many government agencies and services available to help them “go global.”

But when I asked a couple of questions about the IC-DISC, it became clear that among the representatives from government agencies, the federal agency representatives from the Small Business Administration and Export-Import Bank — and even the Chamber of Commerce, all seemed to be oblivious about its existence. The Virginia Economic Development Partnership representative was the only one who was even aware of it. Therefore, I find it not surprising that many exporters have never heard of this benefit.

A BRIEF HISTORY OF THE IC-DISC

The Domestic International Sales Corporation (DISC) was first enacted by Congress in 1971 to encourage U.S. export trade to strengthen the economy. It also aimed to reduce the incentive for U.S. companies to shift manufacturing operations abroad. The DISC provisions were originally enacted to provide a long-term tax deferral on the income earned by a U.S exporter until it is distributed to shareholders as a dividend. This regime actually permits an indefinite tax deferral to U.S. exporters as long as the DISC earnings are invested in qualified export assets and not distributed to shareholders.

Some European countries complained about the DISC regime, declaring it an illegal export subsidy that violated the General Agreement on Tariffs and Trade (GATT) from the very beginning. In 1985, the DISC legislation was modified to add an interest charge on shareholders for taxes deferred due to the DISC provisions, and a new export tax incentive was created by Congress — the Foreign Sales Corporation (FSC).

The FSC gained popularity quickly. Although the tax benefit was smaller as a percentage of profits, it was permanent rather than a deferral and it was not limited in size, while the IC-DISC deferral was only allowed on the most profitable $10 million of export sales. From 1985 through 2004, U.S. trading partners succeeded in the World Trade Organization (WTO) in their claims that the FSC and its eventual replacement, the Extraterritorial Income Exclusion (ETI), were considered to be illegal export subsidies.

Thus, since 2006 when ETI was phased out, the only export tax incentive that has remained in effect is the IC-DISC. Since 1985, owners of an IC-DISC must pay interest to the U.S. Department of the Treasury on the deferred tax of the undistributed earnings. This modification has made the IC-DISC immune to further attacks from the WTO.

The IC-DISC is allowed to invest its earnings in the exporter, keeping the additional cash flow in the business if deferral is used, resulting in a low interest rate loan from the U.S. Treasury. Thus, the U.S. shareholder pays an interest charge on its IC-DISC-related deferred tax liability, which equals the difference between the shareholder’s tax for the tax year computed with and without the accumulated IC-DISC income of the U.S. shareholder that has been deferred over the years. (See Example 1 below.)

DETERMINING THE BENEFITS

An IC-DISC is a C corporation that elects this special status and is not subject to U.S. corporation tax. Therefore the IC-DISC is exempt from income tax on commissions earned from the exporter, and the U.S. exporter can deduct the commission expense paid to an IC-DISC on its tax return, resulting in tax savings to the exporter.

The federal tax savings can be as much as 35 percent in the case of a corporate exporter that pays dividends, as dividends to its shareholders are taxed at 15 percent just like dividends paid out of the IC-DISC, which is generally owned by the same shareholders. Even for flow-through entities, the tax rate differential is still 20 percent because the IC-DISC “converts” regular business income subject to the highest individual tax rate of 35 percent to dividends subject to 15 percent tax. Because of this rate differential, most IC-DISC shareholders currently do not defer income, which offers opportunities for larger exporters to utilize their DISC without limitations on export sales.

The IC-DISC commission is calculated either on 50 percent of the combined taxable income from exports or four percent of qualified gross export receipts, or the arm’s-length amount determined under the transfer pricing principles of Internal Revenue Code Section 482. Exporters seldom use the transfer pricing principles under Section 482 because the IC-DISC would be required to actually purchase and re-sell the export goods.

When an IC-DISC pays a dividend to its shareholders, the individual shareholders pay tax on the dividend at the capital gains rate, while a corporate shareholder would pay tax at regular corporate rates. Thus very few IC-DISCs are owned by C corporations, except when the goal is deferral or the corporate structure does not allow individual or flow-through ownership.

However, IC-DISC shareholders are subject to tax on both actual dividend distributions and deemed distributions. Deemed dividend distributions include the two most common items: 1) the commission income earned by the IC-DISC beyond the first $10 million qualified export gross receipts, and 2) 1/17 of the IC-DISC revenue if owned by a C corporation.

The IC-DISC became much more attractive to U.S. exporters after the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRA) lowered the capital gains tax rate to 0–15 percent and included dividends. If the U.S. exporter is a pass-through entity, such as an S corporation, partnership or LLC, the tax savings is 20 percent, as the distribution is taxed at the 15 percent capital gains rate rather than the 35 percent ordinary income rate. If the U.S. exporter is a C corporation, the tax savings on the IC-DISC earnings equals 35 percent if the C corporation pays dividends. (See Example 2.)

QUALIFICATIONS AND REQUIREMENTS

In order to take advantage of the tax benefits provided by the IC-DISC, the U.S. exporter has to satisfy several requirements, and the IC-DISC has to pass some tests to qualify as an IC-DISC. The U.S. exporter has to meet the following requirements:

• U.S. Manufacturing Requirement – The export property must be manufactured in the United States. The IC-DISC can serve as a buy-sell agent or a commission-based agent. Property is deemed to be manufactured within the United States if either 20 percent of its conversion costs are incurred in the United States and there is a substantial transformation in the United States; or the operations in the United States are generally considered to constitute manufacturing. In addition to goods manufactured in the United States, architectural and engineering services for projects located outside the United States also qualify. There are some specific exclusions for certain goods from the definition of export property, so please seek professional advice before assuming all property qualifies.
• Destination Test – The export property must satisfy a destination test, which means it must be held for sale, lease or rent in the ordinary course of business for use, disposition or consumption outside the United States. Property satisfies the destination test if it is sold to a customer in the United States, provided the property does not need further manufacturing by the purchaser prior to export and the property is shipped to a foreign destination within one year. Under this destination test, the purchasers will have to provide the exporter with information showing that the product was exported outside the United States.
• Minimum of 50 Percent U.S. Content Requirement – The export property should have no more than 50 percent of the value of the final product attributable to foreign components. This is to encourage the domestic manufacturer to employ U.S. suppliers.

STRUCTURE REQUIREMENTS AND QUALIFICATION TESTS

The basic structure requirements of an IC-DISC are:

1. Domestic corporation
2. Minimum of $2,500 capital
3. Only one single class of stock
4. Files the IC-DISC elections
5. Not a personal holding company

• Qualified Export Receipts Test – This test requires that 95 percent of the gross receipts of the IC-DISC be qualified export receipts. Qualified export receipts include commissions from sales of export property, rentals for the use of export property outside the United States and services related to export sales.
• Qualified Export Assets Test – This test requires that 95 percent of the assets of the IC-DISC be qualified export assets. Qualified export assets include accounts receivable, temporary investments, export property and producer loans.

The shareholders of the IC-DISC have several options on the treatment of the DISC revenue depending on the shareholder objectives and corporate goals. After year one, shareholders can take the dividend of the earned IC-DISC income or loan it back to the exporter as a producer loan and earn a small amount of interest income. After year two, shareholders can take the year one income as a dividend or begin deferral.

If the shareholders’ objective is to receive dividends, all IC-DISC income is distributed after year-end to take advantage of the 0–15 percent capital gains rate. If the goal is to defer income, the shareholders may take only part of the IC-DISC income as dividend and defer the income related to the first $10 million of qualified export receipts. Then, before the last business day of the calendar or IC-DISC’s fiscal year, cash needs to be converted to qualified export assets in order to ensure that the IC-DISC meets the qualified export asset test mentioned above. After investing in the qualified export assets, the IC-DISC deferred revenue earns additional interest revenue that is further deferred.

As explained earlier in Example 1, the cost of deferral is an annual interest charge at the current U.S. Treasury bill rate on income taxes on IC-DISC revenue deferred more than 12 months. There is no limit on the total amount of deferral or the length of time deferred. The deferral revenue becomes a low-cost source of funds for the exporter to finance its operations and international sales.

THE FUTURE OF IC-DISC BENEFITS

If the favorable dividend tax rates under JGTRA sunset for tax years beginning in 2011, IC-DISC is facing an uncertain future, as many shareholders have become accustomed to the permanent savings the current rate differential provides. If the dividend received by individual shareholders will be subject to tax at ordinary income rates, the “permanent” benefits of an IC-DISC could largely be eliminated. However, deferral benefits will continue indefinitely. Those benefits are similar to the benefits provided by pension plans and other deferral vehicles, but generally much larger and without any “minimum distribution” requirements.

Based on the current discussions in Congress at press time, there seems to be consensus that the Bush tax cuts, and thus the dividend rate, will stay in place for every taxpayer at least for another year or two, and I note that even before current law, the Obama Administration’s fiscal year 2010 budget proposals would continue some of the tax benefit to IC-DISC non-corporate shareholders with a preferential 20 percent tax rate on dividends. Since the Administration also proposed to raise the highest tax rate back to 39.6 percent, the overall tax benefits should remain relatively unchanged under that proposal as well.

For more information, contact Olaf Barthelmai at obarthelmai@cbh.com.

—

¹American Jobs Creation Act of 2004 (P.L. 180-357)

²Net income from export transaction or “combined taxable income” (CTI) of an IC-DISC is gross receipts less cost of goods sold less apportioned selling, general and administrative (SG&A). Thus the percentage is CTI/gross receipt.

³CTI is combined taxable income, IC-DISC terminology for taxable income from export transactions.

⁴Assuming no other income for illustration purposes, but also assuming that the 15 percent rate applies rather than the 0 percent rate, which would apply if there was no other income.

⁵Assuming other funds are available for distribution, and earnings are not limited to export sales alone.

⁶Assuming interest rates will rise again. This was the rate for 2008.

In his new role at CB&H, Jim will direct the specialized international tax services of the Firm, including global tax strategies, transfer pricing, indirect tax, expat tax, and general international consulting and compliance services. In addition he will be responsible for directing the global resources of the Firm, through Baker Tilly International, to meet the international tax needs of clients worldwide.

Prior to joining CB&H, Jim served as managing director of international tax services for RSM McGladrey’s Southeast practice. He has also previously held senior leadership positions with two Big Four firms.

“Jim’s talent and depth of current, practical knowledge builds upon the significant skills and resources we already have available firm-wide and through Baker Tilly International to help our clients make the most of growth opportunities,” said Kip Plowman, Managing Partner of Strategic Markets for CB&H and the Firm’s Atlanta Market Leader.

Jim brings to the Firm over 20 years of experience serving the international tax advisory and compliance needs of clients across a wide range of industries, including manufacturing and distribution, technology and life sciences, software, real estate and construction, and professional services.

CB&H’s membership in Baker Tilly International gives the Firm’s International Tax practice direct access to the local resources of member firms in 125 different countries. CB&H is a founding member of this alliance, which offers a powerful fusion of local knowledge with over 640 practice offices worldwide.

Jim earned his Bachelor in Accounting and Management from Anderson University, and his Master of Science in Taxation from the University of Cincinnati. He is both a Certified Public Accountant (CPA) and Charted Global Management Accountant (CGMA).

A frequent lecturer and author on international tax matters, Jim is a member of the American Institute of Certified Public Accountants (AICPA), the Florida Institute of Certified Public Accountants (FICPA), and the Ohio Society of Certified Public Accountants (OSCPA).

• 25% for interior lighting systems
• 15% for heating, cooling, ventilation and hot water systems
• 10% for the building envelope

What is Section 179D?

Intended to offset some of the costs of qualifying energy-efficient improvements to commercial buildings, the Section 179D deduction allows taxpayers to take an immediate expense for the cost of property that would normally be recovered through depreciation over as many as 39 years.

To qualify for the deduction, energy-efficient improvements must reduce total annual energy and power costs by 50%. Partial deductions are allowed. Energy simulation is required to justify the deduction, and inspection and testing must be completed by a qualified engineer or contractor registered in the jurisdiction. You can learn more about the deduction by reading CB&H’s Section 179D FAQ.

Energy Savings Percentage Guidance Summary

Do You Qualify for the Deduction?

For more information, or if you would like to discuss whether or not your property qualifies for this deduction, please contact your local CB&H tax advisor or the leaders of the Firm’s Energy Tax Services:

Ron Wainwright, CPA | bio
Partner
rwainwright@cbh.com
919.782.1040

John Denison, CPA | bio
Partner
jdenison@cbh.com
800.849.8281

Also known as the Middle Class Tax Relief and Job Creation Act of 2012 (the “Act”), this new law extends through the end of 2012 the reduced tax rate on:

• the employee’s (but not the employer’s) share of Social Security wages from 6.2% to 4.2%, and
• self-employed earnings from 12.4% to 10.4%

In 2012, the maximum amount of wages or self-employment income subject to Social Security tax is $110,100. Although some taxpayers could save over $2,200 as a result of this legislation, the White House estimates the average tax benefit to be $1,000. The Administration has indicated that it does not, at least for the time being, intend to seek an extension of this tax holiday beyond the end of 2012.

Congress had previously extended the 2% payroll tax break only through the end of February 2012. A recapture provision applicable to taxpayers with income from employment for January and February exceeding $18,350 was repealed as part of the measure. In addition, the Act repeals previously enacted shifts in the timing of corporate estimated tax payments, extends certain unemployment benefits, and blocks a cut in Medicare payments to doctors. The Act raises revenue through an auction of certain airwaves that will allow for more wireless internet systems.

For more information or any questions regarding how this new tax law may affect your business, please contact your CB&H tax advisor.

Risk Factors – The SEC states that disclosure is needed if cybersecurity and cyber incidents are among the most significant factors for investment risk. Companies should consider the frequency and severity of prior cyber incidents and the chance of and risk from future attacks. The SEC specifies disclosures should not be “boilerplate,” and instead detail the following:

• the nature of the business that could lead to cybersecurity risk;
• any outsourcing functions that have material cybersecurity risks and how they are addressed;
• the costs and consequences of an incident;
• the impact of an event or possible event; and
• relevant insurance.

Management’s Discussion and Analysis (MD&A) – The guidance states that the M&D should address cybersecurity risks and incidents if they’ve had or are likely to have a material effect on the organization’s “results of operations, liquidity, or financial condition or would cause reported financial information not to be necessarily indicative of future operating results or financial condition.”

Description of Business – If cyber incidents materially affect a company’s products and services, relationships with customer or suppliers, or competitive conditions, disclosure should be made on the impact the cyber incidents have on each of their reportable segments.

Legal Proceedings – Disclosure is needed if a material pending legal proceeding involves a cyber incident where the company or any of its subsidiaries is a party to the litigation.

Financial Statement Disclosures – Financial statements can be significantly impacted before, during and after a cyber incident, and disclosure should address accordingly. Setting up preventative measures can be costly. And a company may incur cost from damage control efforts that provide customers with incentives to maintain the business relationship. During and after a cyber incident, a company may have significant losses and diminished cash flows that can result in impairment of certain assets.

Disclosure Controls and Procedures – If it is possible for a cyber incident to disrupt an organization’s ability to record, process, summarize, and report information required to be reported in a company’s SEC filings, the company may determine that their disclosure controls and procedures are ineffective. This must be reported.

If you have any questions regarding these developments and what disclosure may be necessary for you organization, or any other matters relating to internal control reporting, please don’t hesitate to contact your local Cherry Bekaert & Holland advisor today.

Although Obama has suggested lowering the corporate rate, Congressional Republicans will likely insist that any reform of corporate tax rules be combined with reforms for individuals. But as reported by Bloomberg, an election-year political stalemate remains the most likely scenario given Obama’s desire to raise the tax rate paid by the nation’s highest earners.

“I don’t think anything is going to happen this session,” said Neal Weber, a tax partner in the Washington office of Cherry Bekaert & Holland LLP. “People are going to posture during the next 10 months through the election.”

One of the biggest obstacles to a corporate tax overhaul is how to pay for it. Obama might seek to raise revenue for lowering the corporate rate by reviving calls to end tax breaks for oil and gas companies or corporate jets. Republicans have blocked such moves in Congress.

Any effort to revise corporate tax laws stands to divide the business community as well. Retail companies, whose assets are mostly inside the U.S., are more focused on lowering the corporate rate. Multinational companies with headquarters in the U.S. are interested in shifting to a territorial tax system, in which only domestically generated income would be taxed.

Obama’s desire to require a 30-percent effective tax rate for those individuals within annual income above $1 million could be proposed in a number of different ways, including limiting deductions, increasing the investment income tax rate, or revising the alternative minimum tax (AMT):

Taxes on capital gains could rise to as much as 25 percent for high earners next year once a new tax included in the 2010 health-care law and a provision that limits itemized deductions take effect, according to Donald Marron, director of the Tax Policy Center, a nonpartisan research group in Washington…. “There’s no way to get there unless you increase the rate on the lower-tax income,” he said. Another alternative for raising taxes for high earners…would be to prevent the deductibility of charitable giving for this group. While the Obama administration has proposed eliminating deductions for housing, health care, retirement and child care for the highest earners, it has spared charitable giving….

Another path could include revisions to the alternative minimum tax, or AMT, which is designed to prevent people from avoiding taxes legally. The parallel tax system doesn’t eliminate the preference for investment income, which is something Congress could change if lawmakers determined that was necessary, said Neal Weber, a tax partner in the Washington office of Cherry Bekaert & Holland LLP.

“In today’s tax law, capital gains are taxed at 15 percent for both regular tax purposes and for AMT tax purposes,” he said. “Perhaps under a new AMT tax regime, you would not use a 15 percent rate. You would use a different rate.”

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• 55.5 cents per mile for business miles driven
• 23 cents per mile driven for medical or moving expenses
• 14 cents per mile driven in service to charitable organizations

Rates for business miles driven remain unchanged from the July 1, 2011 adjustment while rates for medical and moving purposes are reduced by 0.5 cents per mile.

Taxpayers may not use standard mileage rates after using any depreciation method under the Modified Accelerated Cost Recovery System (MACRS), or after claiming a Section 179 deduction for that vehicle. These and other restrictions are outlined in Rev. Proc. 2010-51.

Standard mileage rates for business, medical and moving purposes are based on an annual study of the fixed and variable costs of operating an automobile. Independent contractor Runzheimer International conducted the study.

Taxpayers always have the option of calculating the actual costs of using their vehicle rather than using these rates. Notice 2012-01 contains the standard rates, guidelines for calculating reductions, and maximum rates under fixed and variable rate plans.

Who Does What

User organization – The entity that has engaged a service organization to perform various services for them. For example a company’s employee benefit plan record keeping.

Service organization – The entity that provides services to a user organization. Staying with the benefit plan example, a bank trustee, insurance company or benefits administrator, among others.

User organization auditor – The auditor (i.e., CPA firm) that conducts the financial statement audit on the user organization.

Service organization auditor – The auditor (i.e., CPA firm) that conducts the controls audit at the service organization.

The Act also expands the Work Opportunity Tax Credit (“WOTC”) by creating the Returning Heroes Tax Credit and the Wounded Warriors Tax Credit to encourage employers to hire unemployed and disabled veterans.

Withholding Relief

Originally established by the Tax Increase Prevention and Reconciliation Act of 2005, the effective date of the three percent withholding requirement was postponed twice, most recently scheduled to take effect in 2013. It was intended to help close the “tax gap” created by government contractors and vendors that fail to pay all of the taxes they owe.

However, the provision ignited a firestorm of complaints that tax-compliant companies would be unfairly penalized by cutting their much-needed cash flow. Also, some federal agencies estimated that the cost to implement the requirement would outweigh any potential improvements in tax compliance.

Lawmakers voted with near unilateral support to repeal the provision. This change will benefit government contractors in all sectors, including construction contractors, equipment providers and healthcare institutions.

Employer Tax Credits

The Act expands the WOTC to provide employers with a tax credit equal to 40 percent of a portion of qualified first-year wages paid to new hires from certain veteran groups.

In addition to extending the WOTC for qualified veterans through December 31, 2012, the Act expands the WOTC to allow a credit for hiring unemployed veterans and certain disabled veterans with service-connected disabilities. The Act:

• Doubles the maximum credit, to $9,600, for disabled veterans who have been unemployed for six months or more in the preceding year;
• Adds a credit of up to $5,600 for hiring nondisabled veterans who have been unemployed for six months or more in the preceding year; and
• Adds a credit of up to $2,400 for hiring nondisabled veterans who have been unemployed for four weeks or more, but less than six months, in the preceding year.

In addition to providing tax incentives for hiring veterans, the new law creates or expands several programs that provide training, rehabilitation and other vocational benefits for veterans.

The WOTC is still scheduled to expire on December 31, 2011 for other targeted groups.

Inquire Before You Hire

Please note that employers looking to take advantage of these new credits will need to take several steps before extending a job offer. These steps include checking a prospective employee’s eligibility and completing certain forms. Employers will also need to apply with their state workforce agency for a certification of eligibility within 28 days of the employee’s start date.

If you have any questions about the effect of the repealed withholding or how to claim the Work Opportunity Tax Credit, please contact your local CB&H tax professional. 

In particular, companies operating in a number of industries may benefit from a Repair and Maintenance Study. These will include many in the banking, retail, hospitality, manufacturing, pharmaceutical, warehouse, auto retailers, distribution and utility industries who regularly refurbish or freshen their stores or facilities. These rules will benefit virtually all capital-intensive companies that invest significant dollars on recurring and incidental repairs and maintenance expenses, and capitalized rather than depreciated such costs.

By taking a current deduction of previously capitalized repair and maintenance costs, taxpayers can accelerate deductions that otherwise might not have been available for years. This could lower a company’s tax liability for the current year and possibly generate net operating losses that can be used to obtain a refund of taxes paid in prior years.

How Does It Work?

The purpose of a 263(a) study is to analyze the taxpayer’s business operations, determine appropriate “Units of Property” for purposes of capitalization and depreciation, and identify routine repair and maintenance expenditures that may have been capitalized and depreciated incorrectly instead. A thorough analysis of the taxpayer’s expenses for repairs and maintenance for current and prior years could result in a reduction in the taxpayer’s tax liability, generating tax refunds and thus improve cash flow. Where a taxpayer has been capitalizing the cost of assets that could be expensed as repairs and maintenance costs, a catch-up deduction in the current year can be achieved by filing Form 3115.

What Qualifies as Deductible Repair Costs?

Some examples of repair items we frequently see that may be deductible include the following:

• Remodeling/refurbishing a store concept
• Replacing windows and doors
• Replacing lighting
• Roof repairs
• Wallpapering
• New floor coverings
• Caulking cracks or seams
• Lining basement walls and floors
• Replacing sidewalks and parking lots
• Repairing plaster walls or ceilings

Deductible repairs may also include “incidental repairs” that help to maintain a property’s efficient operating condition but do not necessarily prolong its life, add material value or adapt the property for new or different use. These are not considered as capital expenditures and may also be reclassified to accelerate deductions in the current year.

Final IRS Guidance Expected Soon

Proposed regulations were issued in August of 2006 that define a unit of property as “improved” if the costs paid materially increased the value of the unit of property or restored the unit of property. The 2006 regulations were criticized for not drawing enough of a bright-line test. In March 2008, the Treasury Department and the IRS re-issued Proposed Regulation 1.263(a)-3.

In general, these proposed regulations were intended to reduce controversy and provide clarity on how to determine whether an amount paid must be capitalized under Section 263(a) as an improvement cost. These proposed regulations are expected to be finalized, with revisions, later this month.

Your CB&H tax advisor can help you determine if you would benefit from a Repair and Maintenance Study. Please call us today as it would be our pleasure to help you with this determination.

FOR MORE INFORMATION ABOUT REPAIR AND MAINTENANCE STUDIES, CONTACT:

Ronald G. Wainwright, Jr., CPA | bio
Partner
919.719.4221
rwainwright@cbh.com

Prior to the Jobs Act, a taxpayer could claim a deduction for cell phone expenses only if required substantiation tests were met. These included maintaining books and records of all business use of the cell phone. No deduction was allowed for this listed property unless the taxpayer could substantiate each expenditure or use with adequate records or sufficient evidence.

Fortunately, cell phones no longer fall under the “listed property” category. Pursuant to the Jobs Act, the IRS has issued guidance to clarify the tax treatment of employer-provided cell phones. Notice 2011-72 provides that in the case of an employee’s use of an employer-provided cell phone for reasons related to the employer’s trade or business, the IRS will treat such use as a working condition fringe benefit, the value of which is excludable from the employee’s income.

The cell phone must be issued primarily for non-compensatory business reasons, such as the employer’s need to contact the employee at all times for work-related emergencies, or the employer’s requirement that the employee be available to speak with clients at times when the employee is away from the office or outside the employee’s normal work schedule.

If this standard is met, then any personal use of the employer-provided cell phone will be treated as a de minimis fringe benefit, excludable from the employee’s gross income. The IRS will not require recordkeeping of business use in order to receive this tax-free treatment. Cell phones provided for employee morale, recruiting, or additional compensation are not considered to be provided for qualifying business purposes. Therefore, cell phones provided for such purposes would not be exempt from the burdensome recordkeeping requirements and would not be considered tax-free.

Companies that do not provide their employees cell phones, but instead reimburse for cell phone use, are subject to similar requirements. The IRS recently released a Field Exam Memorandum to its examiners that outlines an administrative approach with respect to arrangements providing cash allowances and reimbursements for work-related use of personally owned cell phones.

In such cases, the employee must maintain the type of cell phone coverage that is reasonably related to the needs of the employer’s business, and the reimbursement must be reasonably calculated so as not to exceed the employee’s actual cell phone expenses. Additionally, the reimbursement must not be a substitute for a portion of the employee’s regular wages.

Under the recently issued guidance, tax-free treatment is available without burdensome recordkeeping requirements for employer-provided cell phones or reimbursement for business use of personally owned cell phones. Keep in mind that this provision only applies to cell phone use and reimbursement that is primarily provided for non-compensatory business reasons.

Whether a worker is performing services as an employee or as an independent contractor depends upon three factors, all related to the degree of control and independence:

1. Behavioral. Does the employer control, or have the right to control, what the worker does and how the worker does his or her job?
2. Financial. Does the employer control the business aspects of the worker’s job? For example, is the worker paid a salary? Does the employer reimburse the worker’s expenses? Does the employer provide the tools or supplies to do the job?
3. Type of relationship. Does the worker receive employee-type benefits? Will the relationship continue after the work is finished? Is the work a key aspect of the employer’s business?

An employer reclassifying workers would pay 10% of the past payroll tax obligations calculated under the reduced rates of IRC Section 3509. Effectively, the employer’s payment would equal just over 1% of the wages paid to the reclassified workers. For example, an employer that paid $500,000 in 2010 to workers, all of whom were compensated at or below the $106,800 Social Security limit, would have a payroll tax liability of $53,400 as determined under the IRS calculation. When reclassifying those workers under VCSP, the employer’s liability is reduced to 10%, or $5,340.

In addition to enjoying significant tax savings, the employer will not be liable for any interest or penalties and will not be subject to an employment tax audit on the classification of workers in prior years.

To participate in VCSP, the employer must have consistently treated the workers as nonemployees and have filed Forms 1099 for the workers in the previous three years. The employer also cannot currently be under audit by the IRS concerning the classification of workers. The employer’s application must be filed at least 60 days from the date the employer wants to begin treating its workers as employees. Employers who want to begin treating a class or classes or workers as employees for the 4th quarter of 2011 should apply as soon as possible.

Your CBH tax adviser can help you determine worker classification and eligibility for the VSCP. Please call us today as it would be our pleasure to help you with this determination.

• Maximum donation amount for Individuals: $1,000
• Maximum donation amount for joint filers: $2,500
• Maximum donation amount for married filing separate taxpayers: $1,250
• Maximum donation amount for C corporations: 75% of Georgia Tax Liability
  

Who is eligible?
Any Georgia taxpayer

What happens if my donation exceeds my Georgia tax liability?
The tax credit is a “non-refundable” credit. What that means is that you cannot receive a refund for any more than your Georgia tax liability. Any excess credit beyond your tax liability can be carried forward for up to 5 years.

Is this donation a charitable deduction on my federal return in addition to the Georgia credit?
Yes, you are eligible to receive a federal charitable deduction for the amount of your contribution. The law does require that you increase your state income by the amount of your charitable deduction on your federal return (donation amount).

DEADLINE
Submit participation forms as soon as possible to ensure your donation is processed before the program cap is met. The state has placed a yearly cap on the amount of credit available at $50 million. That means that every school, taxpayer, and corporation in Georgia is drawing from the same exact pool of credits. Once these funds are exhausted, you will have to wait until next year to participate in the program. As we near closer to the end of the year, it will become more and more difficult to secure approvals from the DOR in time to make your contribution and receive your tax credit.

HOW TO PARTICIPATE
Contact your local CB&H tax professional today, or consult with the independent school of your choice regarding how to claim the credit.