August 2008

Managing Above-the-Line
Taxes in a Slowing Economy

The following article was contributed by Jeffrey A. Greene, CPA, and Joshua J. Malancuk, CPA, CMI. Both Jeff and Josh are executives in the state tax business unit of Crowe Chizek and Company, LLC in Indianapolis. Jeff may be reached at 317-706-2740 or jgreene@crowechizek.com. Josh may be reached at 317-208-2428 or jmalancuk@crowechizek.com.

As originally published in MidMarket Advantage, a Crowe Chizek and Company LLC publication, Summer 2008. All rights reserved.

As the U.S. economy continues its apparent downturn, companies are under increasing pressure to reduce costs and increase profitability. As authors Jeffrey Greene and Joshua Malancuk explain, making the most of opportunities to save on above-the-line taxes — those that affect pre-tax profits
— can dramatically   improve the bottom line.

Taxes that are entries above the horizontal line on an organization’s profit and loss report can be significant and include sales and use taxes on business purchases, real estate taxes and personal property taxes. Many companies overpay because they are not aware of the myriad regulations, tax laws and filing requirements, and refund opportunities that could reduce their tax burdens. 

The potential for tax savings exists, but businesses in all industries must become familiar with their states’ requirements and plan ahead to obtain the most benefit. Armed with some knowledge, perhaps your organization can increase both before-tax and after-tax profits. 

Taxes Affecting Profit and Loss

Sales and Use Taxes. Sales taxes are potentially due on any purchase from an in-state seller. Use taxes are applied when goods are bought elsewhere and imported into the company’s home state for use, and when a company receives the benefits of services purchased in another state. Many states exempt companies from paying sales and use taxes on qualified purchases, while other states have reduced rates for these items. 

Capital equipment, materials and supplies that will be used in production, for example, are typically tax exempt or have lower sales and use tax rates. To be exempt, companies must give exemption certificates to their vendors. Most states have blanket certificates that cover all purchases, so businesses do not have to present certificates with every transaction. 

Some states use the “direct-pay” approach, in which vendors do not charge sales or use taxes and the purchaser has to decide what’s taxable and pay accordingly. This system is useful for companies that buy in bulk and don’t know in advance how they will use their purchases. For example, a business that buys mass quantities of nuts, bolts and screws might allocate some parts for immediate use and some for use later on, and each batch would have different tax implications.

In some cases, companies might have a third option — the single-rate agreement — in which they agree to pay sales and use taxes for specified purchases at state-defined rates. Rates are usually adjusted every three years based on statistical samples. Unlike the traditional vendor-levied taxes and the direct-pay approach, businesses that use the single-rate agreement forfeit their rights to refunds if they overpay. 

Overpaying sales and use taxes can happen easily. For example, a purchasing clerk is asked to purchase 17 PX5327 repair parts at $3,000 apiece. The clerk doesn’t know what those parts are, if they are exempt from sales and use taxes, or if they qualify for reduced tax rates. The clerk guesses and places the order; if the guess is wrong, the company might have overpaid the tax. 

Organizations that frequently audit their sales and use transaction reports might discover their tax overpayments. Assuming they did not use the single-rate method of calculating their taxes, they can file for refunds, typically within three years from the date they paid the taxes. Before seeking a refund on one item, however, companies should make sure they are meeting all their sales and use tax obligations or risk owing money on something else.

Real Estate Taxes

Companies can overpay real estate taxes if the assessed valuation of their property is incorrect, so obtaining an accurate assessment is crucial to keeping property taxes low. Real property is usually valued by commercial real estate professionals using one or more of three appraisal approaches. The cost approach is based on the cost to acquire comparable land and construct a new building. The sales comparison approach is based on recent sales of similar properties. The income capitalization approach is based on the relationship between the operating income of a property and the estimated value that is paid by an investor when purchasing the property. 

Ideally, assessors would consider all three approaches each time they value property, but unfortunately, they often don’t have the time or resources to do so. Most assessors resort to the cost approach to derive their estimated fair market value. This method, however, may not be a reliable means to develop an accurate fair market value, especially for older properties. Why? Depreciation schedules from costing services might not fully take into account all forms of depreciation, especially with respect to functional or economic obsolescence, opening the door for errors. 

The sales comparison method might be a more reliable method than the cost approach for determining fair market value for property that is more than three years old. The cost approach is less reliable for that property because of the potential for errors in estimating and applying depreciation for physical, functional and economic sources. 

Commercial real estate, typically purchased by investors and leased to tenants, might be valued using the sales comparison approach as well as the income capitalization method, which analyzes net operating income, a comparison of market expenses and a market-derived capitalization rate, establishing the ratio of market value to net operating income. One of the chief difficulties with using income capitalization is that income and expense statements and net operating income from comparable property sales are often unavailable, making it a challenge to develop a market-derived capitalization rate. 

There is no magic bullet when it comes to property valuations. The bottom line is that it’s important for companies to evaluate their real property and, if necessary, to present additional market evidence — typically through an appeal — to properly adjust the assessed valuation. 

Personal Property Taxes

Personal property taxes on equipment and inventory vary considerably from state to state. Some states exempt certain property, such as equipment that protects air and water quality, or specialized tooling such as dies and molds. Other states tax certain personal property at reduced rates. Researching each state’s regulations can identity opportunities for savings. 

Some companies mistakenly leave on their books old equipment that they disposed of, while others forget to note retirements or transfers within the past year; in both cases, the company might be able to file amended returns or prior-year petitions, or both, to recover prior-year personal property tax overpayments and to correct current-year assessments. Companies should make sure that they still own the taxable assets, that those assets are physically located at their facilities, and that as of the assessment date, the assets are being used for their intended purposes.

Weighing the Benefits

Calculating above-the-line taxes and identifying appropriate ways of reducing those liabilities can be a complex task requiring substantial time and effort. The potential savings, however, will often more than outweigh the investment. Seeking above-the-line tax advantages is important whether the economy is in a tailspin or not; but with the chances of a swift economic rebound looking slim, it’s a good idea to get all the savings you can.

Beyond the Economic Stimulus
Act of 2008 for Manufacturers

The following article was contributed by Karim Solanji, J.D., a Director with Paradigm Partners, and Mark Lauber, VP of Marketing for Paradigm Partners. Paradigm Partners is a national tax consulting firm specializing in the R&D Tax Credit. Questions may be directed to Mark Lauber at 281-558-7100 or via email at mlauber@paradigmlp.com. 

The Economic Stimulus Act of 2008, introduced by Congress, not only allowed rebates for individual tax payers, but also created additional incentives for commercial businesses including manufacturers. Previously, bonus depreciation was introduced as a way to help increase cash flow and stimulate the economy during economic downturns.

The bill gives manufacturers a 50 percent bonus deduction on new equipment and increases the limit on expenses that small businesses can deduct from annual income to $250,000, raising it from $125,000.

The result is an increased depreciation deduction which can lower a company's tax liability. The increased cash flow is placed back into the economy through increased investment into the business, and helps create additional jobs.

Can all manufacturers benefit? Only those that are considering expanding a plant or making investments in equipment can benefit from the stimulus package, giving them help "from a cash flow standpoint" in paying for it.

But if your company is not looking into expansion or new equipment, the economic stimulus package does little for you.

Put cash in the bank with interest in 90 days. What if you could get cash back with interest from the IRS within 90 days, would that help? What if that extra cash back ranged from the tens of thousands to the millions? Would that extra cash give you the opportunity to make an investment in equipment or expansion and take advantage of that bonus depreciation? Or could you use the extra cash for other purposes to help your company?

How is this possible? Most manufacturing firms are missing out on five-, six- or seven-figure manufacturing credits. The existing R&D Tax Credit is overlooked because most manufacturers do not understand that their every day activities already qualify for the credits.
And in most cases, neither does your CPA understand because it requires very specialized knowledge and that's why they have never approached you.

It takes a team of specialized tax engineers and IP attorneys to understand which activities qualify and to create the documentation to substantiate those qualifying activities.

Why do you get cash back? The IRS recently changed the rules allowing companies to go back three years and take the credits they missed. Ninety days after submitting amended returns, you will get cash back with interest. And, of course, you can take credits for current and future years if you continue to perform similar activities.

Should my company take a look at this? By the very nature of your business, all manufacturing firms have qualifying activities.

The question is can you actually use them.

To help, if you can answer yes to all of these items, then you definitely need to have an R&D tax consulting firm provide you with a free estimate of your tax credits.

1) Were you profitable in 2004, 2005, 2006 and/or 2007?

2) Is the total cumulative payroll for 2005, 2006 and 2007 in excess of $7.5 million dollars?

3) Is the company structure a C Corp? If so, you are OK. If an S Corp or partnership, do you have five or less shareholders? If so, you are OK.

If you answered yes to those three items, you have an excellent possibility of having a high five-figure credit and into the six- or seven-figure credits for manufacturers with higher wage totals.

The R&D Tax Credit is a wage-based credit, so the higher your total wages, the higher your credits.

Think about what your company can do with the extra cash in about 90 days.

Conclusion. In summary, the Economic Stimulus Act of 2008 can help some manufacturing firms. In addition, the existing R&D Tax Credit can provide much needed cash quickly for all qualifying manufacturers. The refund can be used to take advantage of the bonus depreciation offered by the Economic Stimulus Act, or can be used for other investments
to enhance your business.

Seek out an R&D tax consulting firm to confirm that you qualify and to give you an estimate of your R&D Tax Credits. The sooner you do this, the sooner you'll have additional funds to invest in your company.

Property Tax Exemptions -
A Refresher Course

The following article was contributed by Brent Auberry, an attorney with Baker & Daniels. Brent may be reached at 317-237-1076 or at brent.auberry@bakerd.com.

		The filing date for the most recent round of Indiana property tax exemptions was May 15, 2008. Here is a summary of the rules governing the filing and review process. Indiana law provides, “All or part of a building is exempt from property taxation if it is owned, occupied, and used by a person for educational, literary, scientific, religious, or charitable purposes.” A tract of land is exempt if an exempt building is situated upon it or a parking lot or structure that serves the exempt building is situated on the tract. Personal property (e.g. machinery and equipment, furniture
and fixtures) is exempt from property taxation if it is owned and used in such a manner that it would be exempt if it were a building. To qualify for the exemption, the property must be predominantly used for the exempt purpose.

Property owners were required to apply for property tax exemptions in 2008 (and must also apply in every subsequent even-numbered year, as well as every odd-numbered year in which new property is acquired or the use of the property changes). A property owner must file two copies of a Form 136 exemption application with the county assessor. If an exemption is not timely requested, the exemption likely will be deemed to have been waived and the property will be subject to tax, even if it has been exempted in prior years. No fee is charged to apply. The Form 136 application requires the property owner to identify:

In addition, the property owner must provide copies of: (1) the current property record card, (2) the owner’s articles of incorporation and bylaws, and (3) the owner’s balance sheets and income/expense reports from the past three years. 

The County Property Tax Assessment Board of Appeals will determine whether to grant the exemption. The decision is subject to appeal to the Indiana Board of Tax Review and the Indiana Tax Court.

Given the present environment regarding property taxes across Indiana, assessing officials are expected to exercise increased scrutiny of all property tax exemption applications filed during 2008 and in future years.

IMA Meeting Calendar

OSHA 10-Hour Certification Course
Aug. 20-21
IMA Conference Center, Indianapolis

OSHA 10-Hour Certification Course
Sept. 10-11, 2008
Hampton Inn Southeast
Fort Wayne

Attracting and Retaining Talent in Tough Times
Sept. 23, 2008
Barnes & Thornburg Building, 11 S. Meridian St., Indianapolis

OSHA 30-Hour Certification Course
Oct. 7-9, 2008
IMA Conference Center
Indianapolis

Attracting and Retaining Talent in Tough Times
Oct. 21, 2008
One Summit Square, Barnes & Thornburg Bldg., Fort Wayne

OSHA 10-Hour Certification Course
Nov. 5-6, 2008
Holiday Inn
Terre Haute

OSHA 10-Hour Certification Course
Dec. 3-4, 2008
IMA Conference Center
Indianapolis

To register for any IMA conference, click the link and register online; or contact IMA at 317-632-2474 or 800-462-7762. Additional information is available by contacting Angie Glass at the above numbers or at aglass@imaweb.com.

TaxTalk is published by the
Indiana Manufacturers Association
One American Square, Suite 2400,
Box 82012, Indianapolis, IN 46282
Phone: 317-632-2474
  Toll Free: 800-462-7762    
Fax: 317-231-2320
IMA Web Site: www.imaweb.com
Editorial Layout: Charlene Hickey, chickey@imaweb.com