Companies using the Interest-Charge Domestic International Sales Corporation (IC-DISC) provisions of the tax code, which are intended to help U.S. companies compete internationally, already know that the incentive essentially reduces the top federal tax rate on certain income from qualified goods and services from 39.6 to 20 percent.
“What you may not realize is that the intended and allowable available savings are often much, much greater,” says Amit Mathur, CPA, director at WTP Advisors.
Rob MacKinlay, president of Cohen & Company, says, “Many companies use basic, aggregate IC-DISC calculation methods, though other allowable methods explicitly encouraged in the regulations yield a much higher result. This can be the equivalent of claiming a standard deduction on your individual tax return when itemized deductions are much higher. Many of our clients have dramatically increased savings with a transactional analysis.”
Smart Business spoke with Mathur and his industry peers about IC-DISC and how business owners can extract more value from its proper implementation.
How can IC-DISC savings be maximized?
Most companies utilizing the IC-DISC enjoy the reduced tax arbitrage for either 4 percent of their qualified export gross sales, which is limited to the taxable income from those sales, or 50 percent of the taxable income from qualified export sales. Many believe that these are the maximum amounts used to determine the IC-DISC commission, which is subject to a top rate of 20 percent, rather than 39.6 percent. In reality, these amounts should be considered the minimum commission that results from the two simplest, basic methods.
Truly maximizing the intended and allowable benefits from the IC-DISC requires a more in-depth calculation, but may not take much more time. Each transaction can utilize a choice of many other attractive methods explicitly defined and encouraged in the regulations. For instance, transactions that yield a loss can generate commission. Transactions for products with less-than-average profitability compared with their product group or line also may yield additional benefits.
An analysis utilizing the most beneficial of these methods for different transactions will yield higher results, often more than double, compared with using the basic methods at an aggregate level.
Steve Switaj, CFO of Three D Metals, a company that has used transactional analysis in conjunction with the IC-DISC for years, says, ‘While fluctuation in material prices and unforeseen costs are constant concerns, the increased IC-DISC savings that often results from such variability is a nice feature of the incentive, and enables us to compete in export markets more effectively.’
Can prior year IC-DISC savings be improved?
Re-determinations of IC-DISC benefits can be performed for any open tax years. As Jim Bowen, tax partner at Bober, Markey, Fedorovich & Company, puts it, ‘If the savings from a transactional analysis of IC-DISC benefits is significant, amending the results should be considered, particularly for companies under audit for given tax years.’
Are you overlooking the IC-DISC entirely?
Closely held manufacturers, distributors, growers, software producers, equipment leasing companies, and architectural or engineering firms should consider it.
Mark Klimek, head of the tax practice at McDonald Hopkins, LLC, says, ‘Manufacturers and distributors not fully exploring this incentive may be missing significant tax benefits from a relatively inexpensive to implement government incentive that does not disrupt business operations.’
If products and services are ultimately used outside of the U.S., they will typically qualify. The rules for component parts ultimately sent outside of the U.S. are even more generous — generally, they can even return to the U.S. after being incorporated into another product. Tod Wagner, of Libman Goldstine Kopperman & Wolf, says, ‘Because of the favorable rules defining qualified export property, many companies eligible to use an IC-DISC are overlooking the incentive entirely as they do not think of themselves as manufacturers or exporters. In reality, they may need not to be either.’
Amit Mathur, CPA, is a director at WTP Advisors. Reach him at (216) 292-6732 or email@example.com.
Ready for a complimentary analysis of whether your IC-DISC benefits can be increased? Call Amit Mathur at (216) 292-6732.
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Are you getting the most that you can out of your property? If you’re not using cost segregation — a little-known method to accelerate tax deduction applied to capitalized costs for many property owners and lessees — you may be missing out.
Scott Smith, an associate in the Tax Solutions Group of Plante Moran an affiliate of Plante Moran CRESA, says that this technique is often overlooked during the construction and acquisition of property, but in both of those transactions, it could provide immediate cash benefits.
“Using cost segregation as part of your planning can potentially free up money to do more on your project or to get back on budget,” Smith says.
In many cases, 10 to 30 percent of a building’s cost can be reclassified into shorter-lived asset classes, such as personal property and land improvements. These asset classes have significantly shorter depreciable lives than that of the building itself, allowing for faster write-offs than would normally be available by classifying the building as one item.
Smart Business spoke with Smith about how to apply cost segregation and the benefits you can realize by doing so.
What is cost segregation?
Cost segregation is the process of taking capitalized costs that generally depreciate over decades and doing a detailed engineering study that fully utilizes IRS laws and rules that allow you to accelerate depreciation. A cost segregation professional who is familiar with construction and the tax laws will apply the facts and circumstances to any given facility to maximize the benefit to the property owner.
What are the benefits to undertaking such a study?
Many property owners will put an entire property on their fixed asset schedule as a single line item and, as such, it will depreciate uniformly over time. Cost segregation takes the depreciation that would normally accrue over 39 or 27.5 years and makes it available to be depreciated between five and 15 years. This creates a net present value that frees up money for the taxpayer to do things such as expand the business, fund future projects and buy new furniture.
For example, reclassifying $100,000 in assets from 39-year property to five-year property will result in approximately $19,000 in net present value savings, assuming a 6 percent discount rate and a 40 percent composite tax rate.
What assets can cost segregation apply to?
In an office setting, it can apply to items such as carpeting, wallpaper, decorative lighting and cabinetry. In manufacturing, assets such as process electrical, process piping and HVAC, and equipment foundations should be considered. The depreciable life on these assets is generally five or seven years.
On the outside of a building, look at land improvements such as parking lots, site lighting, landscaping, retaining walls, sidewalks, curbs and gutters. The depreciable life on these assets is generally 15 years.
What types of companies should consider cost segregation?
It is beneficial for companies that have built, renovated or acquired a facility and need to offset some of their income — really, any company that has to capitalize costs that it has paid for. In general, the value of the construction or acquisition should be in excess of $1 million to feel the benefit from a cost segregation study. Companies can even go back in time. Say, for example, you purchased a building in 2006 and put it on your fixed asset schedule. Provided that the documentation and records are good, you can do a cost segregation study in the current year and ‘catch up’ any missed depreciation, all the way back to 2006, in the same year. This missed depreciation is called a 481(a) adjustment and can be claimed by filing the proper paperwork without having to amend any prior tax returns.
When is it a good time to do cost segregation?
The best time to do it is right after you buy, renovate or construct property, for several reasons. The documentation at that time is readily available and not collecting dust in a box somewhere. Also, the people associated with the construction are still available and information is fresh, which ultimately increases the quality of the study because fewer assumptions need to be made.
Who should conduct the study?
Choose someone who’s reputable and qualified. The IRS has issued an Audit Technique Guide that serves as an outline of what a quality cost segregation study includes and who is most capable of doing it.
If you use the wrong person — someone who is not familiar with tax law or construction — that person might not provide the detail that you need to pass an IRS audit if one should occur, which could result in interest and penalties. Make sure that you’re working with someone who understands both engineering and tax law to ensure that you get good results.
Why should companies take advantage of this opportunity now?
For certain years, the IRS has said that not only can you accelerate depreciation through cost segregation, you can also qualify for substantial bonus depreciation in the first year on new property. This year, the rate is 50 percent, which means that you’ll accelerate the depreciation on half of a qualifying item’s value, in addition to the percentage you would normally get in the first year. Imagine depreciating more than half of your new carpeting or parking lot in the first year. If you constructed property in 2011, the rate is an unprecedented 100 percent.
Businesses should take advantage of this opportunity now, as it is currently set to expire at the end of this year.
Scott Smith, LEED AP, is an associate in the Tax Solutions Group for Plante Moran, an affiliate of Plante Moran CRESA. Reach him at (248) 603-5203 or firstname.lastname@example.org.
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