When your organization experiences tremendous growth, there’s an opportunity to expand in ways that might not be as feasible during leaner periods. For many, there’s an increased interest in international expansion and mergers and acquisitions with an eye on continued growth; however, it’s important to consider the tax implications of these decisions before putting them in motion.
In this 2018 third-quarter update, we cover some of the most important tax issues for companies in the technology, communications and media, and life sciences industries and highlight what your organization can do to stay ahead of them.
Safe Harbor for R&D Credit
One of the most common issues raised in an IRS audit is inadequate support for the R&D tax credit. In response, the IRS issued guidance on this matter that would allow taxpayers to rely on safe harbor in certain situations. Learn more.
On August 3, 2018, the IRS issued proposed regulations to clarify the bonus-depreciation eligibility of certain property under Internal Revenue Code (IRC) Section 168(k). Although the regulations aren’t yet final, taxpayers can rely on them for property placed in service after September 27, 2017, and for tax years ending on or after September 28, 2017. Learn more.
Historically, IRC Section 162(m) has generally disallowed publicly held corporations from deducting applicable compensation exceeding $1 million provided to covered employees. Tax reform—commonly known as the Tax Cuts and Jobs Act of 2017—amended IRC Section 162(m), subjecting more companies to this compensation-deduction limitation for highly paid employees.
The IRS recently issued Notice 2018-68 to provide guidance on certain provisions of the amended IRC section deemed integral to its application. The notice answers the following questions:
- Which officers are included when determining a covered employee?
- What’s considered a binding contract?
- How is a contract determined to have been materially modified?
Covered employees include the three officers receiving the most compensation in a taxable year. However, according to the notice, an employee doesn’t have to serve as an executive officer at the end of a taxable year to be considered a covered employee; instead, the primary requirement is simply that the employee earned compensation reported during the applicable tax year.
There are exceptions to the newly modified IRC Section 162(m), which allow certain taxpayers to continue to adhere to the previous version of the law. These are discussed below.
Contract in Effect by November 2, 2017
The first requirement for a taxpayer to qualify for an exception is to have a binding employee contract in effect on or before November 2, 2017. The contract must require the corporation, under applicable law, to pay remuneration if the employee performs certain services or satisfies vesting conditions.
If an employee continues to work with a corporation but is no longer covered by the contract because it’s since expired, the employee’s remuneration is no longer binding and becomes subject to the new Section 162(m) limitations. Similarly, if a contract is renewed after November 2, 2017, the contract isn’t considered in effect on or before the applicable date and isn’t subject to the previous version of the law.
No Material Modification
To qualify for an exception to the updated law, contracts also can’t be materially modified. Material modification generally means an increase in compensation or acceleration or deferral of payment. If the increase is driven by a change in cost of living, the contract isn’t considered materially modified.
The IRS anticipates concerns that weren’t discussed in Notice 2018-68 will be addressed in future proposed regulations—which will likely also include the guidance outlined in this notice.
State and Local Taxes
As discussed in our second-quarter tax update, the US Supreme Court ruling in South Dakota v. Wayfair allows states to assert income and sales nexus on companies that don’t have a physical presence in their state. This likely means additional state income-tax and sales-tax loads in the near future—especially given that some states have already changed their laws, with more expected to follow.
The states that that are looking to change their laws are expected to largely conform to the South Dakota standard for nexus creation for out-of-state sellers, using the following as a threshold:
- More than $100,000 in sales
- Two hundred or more transactions
In response to the Wayfair ruling, some states are enacting laws with varying effective dates while others that had previously enacted laws against enforcing nexus standards are now working with their state court systems to remove those declaratory judgments. Learn more.
Washington Sales Tax
On August 3, 2018, the Washington Department of Revenue announced it will require certain remote sellers to begin collecting Washington retail sales tax by October 1, 2018. This imposes new registration, collection, and remittance obligations on remote sellers that didn’t previously have retail sales-tax reporting requirements. Learn more.
Unclaimed property laws are complex and identifying states with reporting requirements is rarely straightforward. However, there are certain steps that can be taken to determine whether a business has property subject to unclaimed-property laws as well as to identify due-diligence and filing requirements and avoid costly penalties. These reports are generally due by November 1. Learn more.
International Tax Planning
Many companies are still trying to figure out their international tax strategy post–tax reform, asking question such as the following:
- Should they migrate some IP offshore?
- Should they set up international subsidies?
- Why should they do either, and if they do, which countries should they use?
There are many issues to consider, and each company’s situation is unique. Taking time to decide on an international tax strategy before year-end can pay off in the future. Learn more.
Preparing for an Exit
The M&A market is heading into record territory—up 57% globally over the same period last year, according to the Wall Street Journal. Could your company be a target? Companies that prepare early have smoother negotiations and higher valuations. As such, we’ve published articles about three key planning areas:
S Corporation Election Terminations
IRS Revenue Procedure 2018-44 provides guidance for implementing IRC Section 481(d), a provision created under tax reform. IRC Section 481(d) provides rules relating to adjustments required by IRC Section 481(a) that are attributable to certain revocations of S corporation elections, including changing from a cash basis of accounting to a tax basis of accounting—all of which could have a large effect on any M&A activity.
Because of the corporate tax-rate reduction enacted under tax reform, an S corporation may want to terminate its S corporation election to become a C corporation. If a company chooses to do so, it’s important to note C corporations generally are required to use the accrual method of accounting unless they meet the $25-million gross-receipts test described in IRC Section 448(c). This differs from S corporations, which are more often permitted to use the cash method of accounting.
IRC Section 481(d) provides that if a company meets the requirements of an eligible, terminated S corporation, any required adjustments resulting from the termination of the S corporation election will be accounted for ratably during the six-year period beginning with the year of change. This is a deviation from the normal four-year spread for positive adjustments and one-year inclusion for negative adjustments.
To qualify as an eligible, terminated S corporation under IRC Section 481(d)(2), an organization must meet the following requirements:
- Is currently a C corporation but was an S corporation on December 21, 2017
- Revoked its S corporation election between December 21, 2017, and December 22, 2019
- Has stock owners that are the same and in identical proportion on December 22, 2017, and the revocation date
The revenue procedure also provides guidance for eligible, terminated S corporations that are permitted to continue using the cash method after the revocation of their S corporation election but change to an overall accrual method for the C corporation’s first taxable year after revocation. These companies are allowed to account for the resulting positive or negative adjustment required under IRC Section 481(a)(2) ratably during the six-year period beginning with the year of change.
Tax Deferral for Stock Options
Tax reform contained a provision—IRC Section 83(i)—allowing for the deferral of income on certain stock compensation. Eligible employees may elect to defer federal income taxes for up to five years from the exercise of a stock option or the settlement of a restricted stock unit that occurs after December 31, 2017. Those employees may take this deferral only if a number of tests are met concerning the eligibility of the following:
- Employee claiming the deferral
- Specific stock
- Corporation to which the stock belongs
Companies are required to notify their employees that this deferral is available, and the employee making the deferral election must do so within 30 days of the taxable event.
We’re Here to Help
For more information about how any of the topics covered in this third-quarter update may affect your company, contact your Moss Adams professional.