In this fourth quarter update, we cover some of the most important tax issues for companies in the technology, clean technology, life sciences, and communications and media industries and touch on what your organization can do to stay ahead of them.
2016 Year-End Tax Planning Guide
The calendar year is quickly coming to a close, but there’s still time to make some decisions that could help you and your business increase tax savings. While there has been very little legislative change this year, there are still existing opportunities to consider. We just released our annual year-end tax planning guide, covering key opportunities and developments that individuals, businesses, and business owners need to be aware of going into 2017.
New Federal Tax Due Dates
Due dates for 2016 tax returns due in 2017 are changing. A summary of the revised due dates are as follows. See our Alert for more details.
Tax Changes Ahead
Prospects of tax changes are high with the election of Donald Trump as president and the Republicans holding both chambers of Congress. While it isn’t clear what changes will be enacted, early signs point to lower tax rates and some simplification.
Trump’s tax plan focuses on reducing individual and corporate taxes. He wants to reduce the number of individual tax brackets from seven to three by removing the upper brackets. He also proposes getting rid of the estate tax and capping deductions. The bump in discretionary income for individuals could provide short-term growth to the US economy. However, it could also be argued that increasing income for individuals doesn’t have the same multiplier effect on the economy as incentivizing businesses to increase capital expenditures.
Trump’s tax plan also includes reducing the corporate tax rate to 15 percent. The US corporate tax rate currently is among the highest in the world.
He also plans to provide a tax holiday to multinationals in order to repatriate cash held within foreign entities. This is likely to have a small economic benefit in the short-term, as corporate America is already flush with cash. Read an article by our chief investment officer for an in-depth look at possible economic changes under a Trump presidency.
R&D Tax Credits
Final R&D Tax Credit Regulations
Final regulations for the R&D tax credit expand and clarify the definition of internal use software (IUS). This is important for all companies, not just software companies, because the tax credit is now more readily available to small businesses and others whose software development activities may not previously have been eligible for the credit. See our Alert.
Offset Payroll Taxes Due in 2017
As a reminder, the Protecting Americans from Tax Hikes (PATH) Act of 2015 included some enhancements that took effect in 2016, including offsets to alternative minimum tax and payroll tax for eligible businesses. The credit is still based on credit-eligible R&D expenses, but offsets apply to only those costs incurred since January 1, 2016. The new payroll tax offset allows companies to receive a benefit for their research activities regardless of whether they’re profitable. New businesses or start-up companies may be eligible to apply the R&D tax credit against their payroll tax for up to five years. More information is available here.
Intra-Asset Transfer Simplification
In October 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2016-16 as part of its initiative to reduce the complexity in accounting standards. ASU 2016-16 addresses the tax accounting related to transfers and sales between entities. Generally, the income tax effects of transactions are generally recognized as they occur. However, the exception applies to recognition of current and deferred income taxes on intra-entity asset transfers.
The new guidance eliminates the exception for all intra-entity sales of assets other than inventory. Both seller’s and buyer’s tax consequences are recognized when the transfer occurs even though the book profit from such transfers are eliminated in consolidation. Before the issuance of ASU 2016-16, the buyer and the seller in a consolidated reporting group were generally required to defer the income tax consequences of intra-entity asset transfers when the book profit from such transfers were eliminated in consolidation. Both the seller’s and buyer’s tax consequences were recognized when the asset was sold to an outside party or, in the case of long-lived assets, in one or more subsequent periods.
ASU 2016-16 is adopted through a modified retrospective approach. The cumulative effect adjustment is recorded in retained earnings from:
- Recognition of unamortized tax expenses previously deferred from the seller, like the reversal of prepaid tax asset against retained earnings
- Recognition of deferred tax assets, like excess stepped up tax basis over financial statement carrying basis, net any necessary valuation allowance by the buyer
For public business entities, ASU 2016-16 is effective for annual periods beginning after December 15, 2017, and interim periods within those annual periods. For all other entities, the amendments are effective for annual periods beginning after December 15, 2018, and interim periods within annual periods beginning after December 15, 2019.
State Tax Updates
In September 2016, the California Franchise Tax Board (FTB) issued FTB Notice 2016-02 explaining how the FTB will treat “otherwise valid” water’s-edge elections when a unitary foreign affiliate of a California water’s-edge taxpayer has sales in California that exceed California’s economic nexus threshold. The FTB lists conditions which, if met, would result in the FTB not seeking to terminate a taxpayer’s water’s-edge election as a result of its foreign affiliate establishing economic nexus. Taxpayers that have a water’s-edge election in place and that have foreign affiliates with sales to California should carefully review the impact, if any, of California’s economic nexus rule on the status of their water’s-edge election in light of this FTB notice.
Legislation effective August 31, 2016, specifically expands Pennsylvania’s 6 percent sales and use tax to sales of digital products delivered to a customer electronically, digitally, or by streaming. Common examples of digital products include video, music, books, apps, games, and canned software. Transferred electronically means the product is accessed or obtained in a way other than a USB drive, DVD, or other physical storage. See our Alert.
Effective April 1, 2016, Louisiana adopted legislation including “click through” nexus provisions. These provisions mean that an online retailer who gives a Louisiana resident or business a referral fee or discount in exchange for linking to the retailer’s Web site on a businesses’ or residents’ Web site may now be required to collect tax on sales to Louisiana customers. The enacted legislation also includes “affiliate nexus” provisions. Affiliate nexus allows states to require out of state retailers to collect tax on sales to customers in the state if the retailer has an affiliated agent that sells the same or similar products under the same or similar name.
Deductible Compensation Limits
Internal Revenue Code (IRC) Section 162(m) limits the amount of deductible compensation a company can pay its CEO and top four other most highly compensated officers. The limitation can be mitigated through planning and additional administrative hoops, which many companies are reluctant to implement.
In instances where a Securities and Exchange Commission (SEC) registrant subject to Section 162(m) is acquired during the year, officers often receive large payouts, stock options, and grant accelerations that result in even higher compensation. Absent the planning and administrative hoops referred to above, this normally would result in large compensation amounts being disallowed for tax purposes under Section 162(m). Several private letter rulings discuss this scenario and how compensation in the pre-acquisition short period return isn’t limited under IRC 162(m). Please consider this for any SEC registrants being acquired.
Final 385 Regulations
On October 13, 2016, the US Department of Treasury and IRS released final and temporary regulations under Section 385 that address whether certain instruments between related parties are treated as debt or equity. There are over 500 pages of regulations and an enormous amount of detail. At a high level, it generally applies to inbound investments.
The final regulations generally apply to debt instruments that are:
- Issued by a “covered member,” currently defined to mean a domestic corporation or a disregarded entity of a covered member
- Held by a member of the issuer’s “expanded group,” which generally includes all corporations connected to a common parent that owns, directly or indirectly, 80 percent of the vote or value of each connected corporation
- Not held by a member of the issuer’s consolidated group, which is treated as a single corporation
- Not issued by an S corporation, a noncontrolled regulated investment company, or a real estate investment trust as nonexpanded group members
The final regulations require contemporaneous documentation requirements on certain related party debt instruments issued by a domestic corporation as a prerequisite to treatment of such instruments as debt; otherwise, such instruments are treated as equity and subject to a rebuttable presumption.
The final regulations also treat as stock certain debt instruments issued by a domestic corporation to a related party by way of, or in connection with, certain distribution and acquisition transactions that don’t introduce new capital into the broader related party group.
Keep in mind that there are numerous exceptions in the regulations and a lot of detail that companies will need to work through. Generally, these regulations are effective in 2017; however, there are some delayed implementation provisions and other complexities that should be considered when addressing these regulations.
We're Here to Help
Moss Adams LLP continuously reviews the regulatory and tax landscape for technology, clean technology, life sciences, and communications and media companies. For more information about any of the issues discussed above, or for insight on how they may impact your business, contact your Moss Adams professional.