October 2011

Permanent Tax Benefit Found in IRC Sec. 1202

The following article was contributed by BKD, LLP. For more information, contact BKD online at www.bkd.com.

Internal Revenue Code (IRC) Section 1202 provides an increasingly rare type of benefit: a permanent tax benefit. While Sec. 1202 is not new—it was first introduced in August 1993—Congress’ most recent modifications are extremely favorable to taxpayers, causing practitioners and taxpayers to revisit the benefits available by qualifying stock as Sec. 1202 stock.

Congress intended to encourage new entrepreneurial capital investment through Sec. 1202, specifically in the form of C corporations. Sec. 1202 originally provided a permanent 50 percent exclusion from qualifying gains income. While this sounds good on the surface, the 1993 law included some alternative minimum tax (AMT) preference strings. These strings, as well as a lack of taxpayer and tax practitioner knowledge, caused many taxpayers to ignore or not be aware of Sec. 1202. In 2009, Congress modified Sec. 1202 to provide a 75 percent exclusion, but the AMT preference strings remained.

In contrast, the current provisions of Sec. 1202, introduced in late 2010, provide for a permanent exclusion from income of 100 percent of qualifying gains, and the AMT strings have been severed. The exclusion from income is limited to the greater of 10 times the taxpayer’s adjusted basis in the stock or $10 million; these limitations apply to a taxpayer’s cumulative investment in the stock of the qualifying corporation.

To qualify for the 100 percent exclusion, the stock must be acquired after September 27, 2010, and before January 1, 2012. To qualify for the 50 percent exclusion, the stock must be acquired after August 10, 1993, and before February 18, 2009, while stock acquired after February 17, 2009, and before September 28, 2010, qualifies for the 75 percent exclusion from income.

To benefit from Sec. 1202 treatment, the taxpayer must clear a number of hurdles. Here are some of the requirements that must be satisfied for stock to qualify under Sec. 1202:

These do not fully represent all of the issues and difficulties that could arise in trying to determine whether stock qualifies under Sec. 1202. There are a number of areas for potential difficulty in determining whether acquired stock meets all the required tests. In particular, certain redemption transactions that may occur shortly before or after the issuance of stock will deny Sec. 1202 treatment to newly issued stock. These stipulations were intended to reward entrepreneurial effort, while denying these rewards to taxpayers who merely substitute one investment for another, even if the original investment was not their own.

Also note Sec. 1202 is not elective. However, to take advantage of the benefits, the status needs to be recognized by both the taxpayer and tax practitioner so it can be properly documented upon acquisition and claimed upon sale.

Oh Where, Oh Where, Oh Where
Have the Indiana Recovery Act Dollars Gone?

The following article was contributed by Daniel P. King, an attorney with Frost Brown Todd LLC. For more information, contact Daniel at 317-237-3957 or dking@fbtlaw.com.

		It has been over two years since the completion of the first construction project funded through the American Recovery and Reinvestment Act (“Recovery Act”). In July 2009, the Indianapolis Executive Airport’s runway was reconstructed at a cost of approximately $3.4 million. As of
June 30, 2011, Indiana is set to receive more than $4.5 billion in Recovery Act funding. Of this amount, Indiana has already received $3,258,419,927. So how has our share been allocated and spent?

Before detailing how Recovery Act funds were dispersed in Indiana and in order to bring context to these dollar amounts, it is helpful to review the overall nationwide distribution of all Recovery Act funds. Recovery Act funding is broken down into three basic categories: 1) Tax Benefits; 2) Contracts, Grants & Loans; and 3) Entitlements.

Tax Benefits
As of the end of June 2011, $259.9 billion of the $288 billion set aside for tax benefits has been paid out. Of that amount, over $122 billion was allocated for individual tax credits, including credits to first-time homebuyers, transportation subsidies, and education benefits. Another $89.3 billion went to tax credits for working individuals. $33.5 billion was provided to businesses in the form of the Work Opportunity Tax Credit (unemployed veterans) and Net Operating Loss Carryback (offset of losses via tax refunds). Other “tax benefits” included energy incentives ($9.3 billion) and offsetting the costs of COBRA premiums ($3.7 billion).

Only $2.1 billion of the $259.9 billion of “tax benefits” directly benefited the construction sector. Of this amount, $500 million was expended on Build America Bonds to reduce the cost of borrowing for state and local governments, $330 million for manufacturers of clean technology, and $140 million for rehabilitation, repair and equipping of schools.

Contracts, Grants & Loans
One might assume that the construction industry fared much better in terms of receiving direct benefit from funds allocated under the category of “Contracts, Grants & Loans.” At the mid-point of 2011, approximately $223.3 billion of funds were dispersed in the form of contracts, grants or loans. This is about 81% of the funds earmarked for this category, leaving approximately $52 billion to be allocated. Of the $223.3 billion spent, over $84 billion went towards education, which included $47 billion to stabilize state education budgets, $16 billion for student financial assistance, $10 billion for special education, and $9 billion for compensatory education for the disadvantaged. Again, the lion’s share of the funds earmarked for education did not directly benefit the construction industry in terms of actual dollars spent on infrastructure construction and improvements.

Approximately $29.6 billion has been expended for highway infrastructure, high-speed rail corridors, and airport improvements. More than $21 billion of these funds were used for highway infrastructure investment. Another $5 billion was used for mass transit, $1.2 billion for capital grants for railroad improvements and $1 billion for airport improvements. Heavy highway and equipment contractors received a direct benefit from the expenditure of these funds and, as detailed later, roughly 20 percent of the Recovery Act funds expended in Indiana were for highway improvements in 2009--2011.

Approximately $27 billion of the total Recovery Act funds was expended on various energy and environmental initiatives, including but not limited to energy efficiency and renewable energy programs. Another $21 billion was used for infrastructure improvements, including EPA grants ($5.3 billion), improvements to federal buildings ($2.4 billion), operation and maintenance for the Army ($1.2 billion) and for the Air Force ($962 million). Another $16.1 billion was spent on housing initiatives, $13.1 billion on health related programs and $10 billion on research and development costs.

Entitlements
It does not appear so far that the construction industry, besides the heavy highway and equipment sector, has received much direct benefit from the allocation of Recovery Act funds. $224 billion was set aside for Entitlements. Of this amount, approximately $187.7 billion has been paid out. The top recipients of entitlements were state Medicaid programs ($84.6 billion), unemployment insurance programs ($60.8 billion), family services ($28.7 billion) and economic recovery payments ($13.8 billion).

Indiana’s Share and Usage of Recovery Act Funds
The financial data and dollar amounts set forth in this article are from the U.S. government's official website that provides easy access to data related to Recovery Act spending. See http://www.recovery.gov. This website also provides detailed information about Recovery Act spending for Ohio, Kentucky, Tennessee and West Virginia.

Indiana’s share of these expended funds is truly a “drop in the bucket.” Only $3.2 billion of the $670.9 billion of Recovery Act funds expended was received for use in Indiana. That is less than one half of one percent of the total Recovery Act funds expended! In comparison, California has received $19 billion or 2.8% of the total Recovery Act funds expended and New York has received just shy of $11 billion or 1.6% of the total Recovery Act funds paid out.

Of the $4.5 billion Indiana is scheduled to receive, some of the largest “non-road” construction projects being funded by the Recovery Act include $94 million for improvements to water and sewer lines (43 total projects), $133 million for the weatherization of residential houses, and $118 million to upgrade the electrical, mechanical and plumbing of Enerdel, Inc’s existing facilities. Funds passed through INDOT were used for over 1,000 projects throughout the state’s 92 counties. Over $621 million has been paid to INDOT for infrastructure improvements.

Has spending $3.2 billion over the last two years benefited Indiana’s construction industry? According to the U.S. government, approximately 6,000 Indiana jobs have either been “created or saved” by these expenditures. Stated differently, each Indiana job created or saved came at a cost of over $500,000. In California, the cost was approximately $360,000 per job created or saved; and in New York, the cost was approximately $279,000 per job created or saved. Although there was a 2 percent increase in construction employment this past year, the overall construction employment in Indiana is still down 23 percent from the state’s peak in March 2000.¹ Until the remaining $1.3 billion allocated to Indiana is actually received and spent, the extent of the total benefit to Indiana’s construction industry remains uncertain.

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1) The Associated General Contractors of America, The Economic Impact of Construction in the United States and Indiana, April 26, 2011. See http://www.agc.org/galleries/econ/INstim.pdf. 

Tax Breaks to Consider for 2011

The following article was contributed by Craig Conley of Clifton Gunderson. Craig can be reached at Craig.Conley@cliftoncpa.com or 317-574-9100.

Keeping track of current tax legislation can be daunting. Here is a summary of several developments that offer opportunities for businesses in different sectors to reduce their tax liabilities.

100 Percent Bonus Depreciation
100 percent bonus depreciation is temporarily available for qualified investments made before Jan. 1, 2012, creating a strong incentive to upgrade or purchase new equipment and tangible property. For qualified property placed in service in 2012, 50 percent bonus depreciation is scheduled to return. For Indiana purposes, the bonus depreciation is not allowable; and an adjustment is made to compute adjusted gross income as if no election had been made. Unlike Section 179 expensing (see below), bonus depreciation is not capped at a certain dollar level.

Section 179 Expensing Levels Available Through 2012
Section 179 expensing limits were set at $500,000 and investment limits at $2 million for 2010 and 2011 by the Small Business Jobs Act of 2010. The Tax Relief and Job Creation Act of 2010 holds the expense limit at $125,000 and the investment limit at $500,000 for 2012. For Indiana purposes, an adjustment of any Section 179 deductions taken for federal income tax purposes in excess of $25,000 is required.

Among the expenses that may qualify:
• Equipment (machines, etc.) purchased for business use
• Tangible personal property used in business
• Business vehicles with a gross vehicle weight in excess of 6,000 lbs.
• Computers
• Some computer software
• Office furniture
• Office equipment

R & D Tax Credit Through 2011
The research and development tax credit was allowed to expire at the end of 2009, but a two-year extension has made it retroactive to Dec. 31, 2009, and is now available through the end of 2011. The State of Indiana also allows a research and development credit for qualified activities that take place in Indiana. While companies might not typically see themselves as engaged in research and development, they may be involved in developing or improving products, processes, techniques, formulas or software. Therefore, it may be worth exploring the opportunities presented by this long-standing tax break.

Payroll Tax Cut Lasts Through 2011
The Tax Relief Act of 2010 temporarily reduces the OASDI (Old Age Survivors Disability Insurance) portion of the Social Security tax for wage earners from 6.2 percent to 4.2 percent. This “tax holiday” for employees only – employers must still pay their portion of the Social Security tax. The holiday will continue through 2011, at which time the 6.2 percent rate will return.

HIRE Act Bonus Credit
Last year’s HIRE Act (Hiring Incentives to Restore Employment) offered employers an exemption from Social Security payroll taxes for qualified workers hired any time after Feb. 3, 2010 and before Jan. 1, 2011. If those workers remain on the payroll for 52 consecutive weeks after their initial hire, the employer may be able to take an additional $1,000 credit for each employee.

Indiana EDGE Credit
Indiana allows an EDGE (Economic Development for a Growing Economy) refundable tax credit to taxpayers who create new jobs or retain jobs in the state. Taxpayers must apply to the Indiana Economic Development Corporation and certain conditions must exist to apply for the credit.

New Markets Tax Credit
The IRS has proposed changes to the New Markets Tax Credit to promote investment in non-real estate businesses in low income communities. Details of the proposed changes area available at the Community Development Financial Institutions Fund (www.cdfifund.gov) website. Public comments on the proposed changes will be accepted until Sept. 8, 2011.

Changes to the R&D Tax
Credit That Can Increase Employment

The following article was contributed by Zee Makhani, Senior Engineering Director, and Brian Cameron, EVP of Business Development, both of Paradigm Partners. Please contact Mark Lauber if you have any questions. Mark's email is MLauber@ParadigmLP.com and his phone number is 281-558-7100 X-105. Also, you may visit www.ParadigmLP.com to learn more.

It has been well established that the R&D Tax Credit has been instrumental in increasing the amount of research conducted domestically, keeping manufacturing jobs here in the U.S. as opposed to low labor cost countries such as China, as well as adding highly skilled and technical jobs to our workforce. Originally enacted in 1981 by the Reagan Administration, this credit has been extended by Congress 14 separate times. The latest extension was in 2010 and will last through the 2011 tax year.

Throughout America, business owners are faced with constant changes in economic policy, forcing them to be extremely hesitant before hiring, expanding, or investing in their businesses and ultimately their future. A report released by The Office of Tax Policy in the United States Department of the Treasury titled "Investing in U.S. competitiveness: The Benefits of Enhancing the Research and Experimentation (R&E) Tax Credit," on March 25, 2011, shows that over 12,000 corporations and 64,000 individual owners claimed this tax credit, representing hundreds of thousands of jobs.

A common complaint that businesses have is the constant uncertainty in relation to taxes, regulations, health care costs, etc. With such poignant fears, who can blame them for being reluctant about bringing on new people? For companies that have taken advantage of the R&D tax credit, or for those companies considering taking the credit, the uncertainty that arises every year can begin to be mitigated by making this credit permanent. If companies cannot depend on the credit being there for them in a soft economy such as the one that we live in now, then they are more likely to continue their freeze on hiring.

"That's why, as part of corporate tax reform, the president supports making the R&E (R&D) tax credit permanent to give businesses the certainty they need to make these important investments. In addition, the administration wants to expand the credit by about 20 percent, the largest increase in the credit's history, and simplify it so that it is easier for firms to take this credit and make the investments our economy needs to compete."

The above quote was taken from President Obama's FY2012 Budget proposal, page 37, urging the administration to expand, simplify, and make permanent the R&D Tax Credit. The end result would bring more jobs to Americans in several ways:

• Business owners would be certain that the credit is available every year;
• More business owners would take the credit because it is easier to calculate; and
• The credit would be larger, creating the necessary cash flow to hire new employees.

Apparently, there is agreement from several high-ranking senators. Another bill was introduced on September 19, 2011 by the Senate Finance Committee Chairman, Max Baucus (D-Mont.), and Ranking Member, Orrin Hatch (R-Utah), to do what the president has proposed. The Baucus-Hatch proposal, called the "Greater Research Opportunities with Tax Help Act of 2011 (GROWTH Act)," is cosponsored by eight other senators.

"By giving businesses a leg up on the competition in this global economy, we can help them grow and create the jobs American families need. Our workers are facing competition from countries across the globe, so this boost to innovation and research here at home is critical to our economy," Baucus said regarding the bill. He added, "Making the research and development tax credit simple and permanent gives innovative American businesses the certainty they need to
make job-creating investments and the ability to compete in markets across the globe."

Another long-needed change to the R&D tax credit that is being considered, is allowing tax payers who are subject to AMT (Alternative Minimum Tax) to use their R&D tax credit as a direct offset of said AMT. This is very similar to legislation passed in October of 2010, entitled 'The Small Business Jobs Act,' which allowed taxpayers to do just that, but only for tax year 2010.

In conclusion, the economy needs a boost and putting the unemployed back to work in high-paying jobs can help. By making a few minor changes to the tax code with respect to the R&D tax credit including making it permanent, there is a potential for adding hundreds of thousands of new jobs by small businesses.

IMA Meeting Calendar

What Happens When a Deal
Goes Bad? Srategies for Resolution
Oct. 19, 2011
Online Webinar

What's Personal, What's the
Company's and What Are the Risks?
Nov. 2, 2011
Online Webinar

OSHA 10-Hour Voluntary Compliance Course
Nov. 9-10, 2011
IMA Conf. Center, Indianapolis

Latest NLRB Developments/
Top 10 Mistakes in Employment Law
Nov. 16, 2011
Online Webinar

OSHA 30-Hour Voluntary Compliance Course
Dec. 5-8, 2011
IMA Conf. Center, Indianapolis

To register for any IMA conference, click the link and register online; or contact IMA at 317-632-2474, ext. 237 or 800-462-7762, ext. 237. Additional information is available by contacting Angie Glass at the above numbers or at aglass@imaweb.com.

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