Problems with the launch of the federal health insurance exchange website are removing it as an option for many employers and employees this year.
“How can I advise someone whether to enroll in an employer plan or buy from the exchange when I can’t get on the exchange to make a comparison before the employer’s open enrollment period is up? For the 33 states with a federal hand in operating the exchange, it’s nearly impossible to get any data,” says Paul J. Baranowski, CLU, ChFC, team leader in Account Management at Benefitdecisions, Inc.
Smart Business spoke with Baranowski about strategies to consider in the wake of the problematic launch of the exchange.
How are health plans changing as a result of the exchange?
On the employer side, there’s a stronger move toward defined contributions, providing a set dollar amount and letting employees chose their plan. In the past, there was concern this approach might be too hard on employees with families. It’s easier now for companies to make this transition because the Affordable Care Act (ACA) can be cited as a reason for change.
For larger-sized employee groups, cost increases are still primarily driven by the group’s own claims experience. However, many small to midsize, fully insured employer groups are facing sizable premium increases due to insurers’ expectations of an influx of less healthy people coming on the books, pass-through ACA fees and less flexibility in underwriting methodology. These employers may have little choice financially but to move to something like defined contribution plans.
From a regulation standpoint, a defined contribution plan potentially sets up a method for allowing family members to get subsidies to purchase coverage through an exchange, once ACA is revised to accommodate this. Clients in the hospitality, restaurant and retail businesses are moving toward plans that are purposefully unaffordable — the plan meets minimum coverage requirements but is too expensive, so employees go to the exchange and get a subsidy. Because these industries have a high degree of turnover, the business risk of paying $167 for every month an employee is on the exchange is a fairly low liability.
Exchanges are also giving an extended life to employers putting in a health reimbursement account (HRA) underneath a high-deductible health plan. While employers need to be careful about some new restrictions, and the HRA has to be integrated with the medical plan, this can mitigate employees’ costs while reducing total employer fixed premium costs.
In addition, there’s a strategy that involves offering a plan with minimum essential coverage, which can mean providing unlimited preventive-care-only coverage. This would push employees to get coverage through exchanges and qualifies them for the subsidy.
When do you expect the problems with the exchange will be worked out?
It will take several years to bring stability and less complexity to the market. With all of the uncertainty, plus ACA medical loss ratio rules, carriers won’t take the risk of selling underpriced plans since they’re no longer allowed to recoup losses.
Unfortunately, this means no real price advantages just yet to employers purchasing health coverage, whether in or out of exchanges. There still isn’t any serious movement on affecting the cost of health services and changing behavior at the individual level, but at least there will be more plan choices to give to employees.
On the flip side, reform has several positive advantages. It’s a huge plus for people with preexisting conditions who had been denied coverage, particularly the many small business owners or sole proprietors who previously had to make tough life decisions, such as putting off retirement, because they couldn’t get a decent health plan. This also has closed the door on what once was a possible problem when switching employers.
Although some positives exist, nothing in health care is free — that’s being clearly demonstrated. As a result, even small employers need to explore all possible strategies, keep up on the continuous regulatory changes and be ready to consider doing something unconventional. ●
Insights Employee Benefits is brought to you by Benefitdecisions, Inc.
Although some aspects of the Affordable Care Act remain uncertain, the act overall is driving the health care market to figure out ways to control costs and allow employers to continue to offer health plans, says Mark Haegele, director of sales and account management at HealthLink.
As a result, managed care companies are increasingly utilizing three tools —reference-based pricing, Domestic Centers of Excellence and narrow networks.
“Some of these concepts are still new, so an employer might tackle one thing at a time,” Haegele says. “Maybe you start with narrow networks, and then move into reference-based pricing or Domestic Centers of Excellence.”
Smart Business spoke to Haegele about how each strategy can drive down costs and the overutilization of health plans.
How does reference-based pricing work?
Within a managed care network, you identify facilities, procedures and/or services that have low costs and high quality, and then establish a plan design that drives plan members to them. If, for example, you’ve identified that
Provider A performs knee replacements for $5,000, then members who go to that provider have their costs covered at 100 percent. If a member goes to another more expensive provider, he or she is responsible for the difference. This schedule could cover a whole host of surgeries and procedures.
Reference-based pricing, which is cutting edge in both contracting and plan design, can have a major impact on costs.
What are Domestic Centers of Excellence?
With this model, you identify high-quality providers across the country to be the hub for a certain procedure type. For example, all transplants might go to the Mayo Clinic, while all knee, hip and shoulder replacements go to Mercy Springfield Missouri. The health plan promises to pay 100 percent for the procedure and the travel for the member and a caregiver, as opposed to just giving a deductible and coinsurance.
The value isn’t just with price points, but also aligning incentives. Providers are willing to offer preferred pricing based on the exclusivity and volume, and employers achieve savings on unit cost. In addition, unlike the traditional fee-for-service model, providers objectively review for appropriateness first. The contract includes a performance component to eliminate waste. So, Mercy, which performs 30 percent fewer back surgeries than the national average, keeps members from getting inappropriate surgeries.
Originally only used by large employers, this model has become more prevalent. Smaller employers can piggyback on either large employers or a managed care network that develops this for its entire block of business with specialized contracts.
How do narrow networks lower health costs?
Depending on your geography and population, you may be able to partner with your managed care network to customize your network. In a rural or smaller market, this may mean exclusively driving the members to one facility. In turn, typically the hospital will provide a better managed care contract.
You may get pushback from members who prefer one facility to another. The employer must convey that this is about looking at cost and quality to find the right facility, which then has an impact on premiums.
Narrow networks have been around for a while, but now managed care companies are starting to wire together narrow networks across a region to create a sub-network.
Can these strategies be used in conjunction with any type of health plan?
Although there is some overlap, you can use a combination of strategies, depending on your readiness for change. The difference is more of a degree of granularity — Domestic Centers of Excellence and reference-based pricing are broken down by procedures, while narrow networks are more geographic-centric.
Self-funded health insurance plans may use any of these tools. Fully insured carriers are now implementing narrow networks and referenced-based pricing. With the health exchanges, narrow networks should become more common as carriers look for ways to keep costs down. ●
Insights Health Care is brought to you by HealthLink
First, the Small Business Health Options Program (SHOP) health insurance exchange was delayed. That was followed by a delay in the release of community ratings for small group programs. On top of that, there’s confusion about whether businesses with less than 50 employees, which are not governed by the Affordable Care Act (ACA) mandate to provide health insurance, can utilize health reimbursement accounts (HRAs) to buy individual coverage.
“The ACA places significant limitations on HRAs, and they are the only vehicle these companies have to distribute dollars employees can use to pay for premiums. The question is whether businesses that are exempt from the mandate are impacted by other aspects of the ACA. There will need to be some guidance as to whether it applies,” says William F. Hutter, CEO of Sequent.
The delays and uncertainty have left small businesses with few options for health insurance at a time when they need to finalize plans for 2014.
“That inherently creates a violation of rules because there’s a 60-day notice requirement to inform employees of any plan changes,” Hutter says. “We think the notice will be interpreted so that companies might be able to make a plan change, but not a cost change — the employer would have to pick up any difference. But that factor also has to be determined.”
Smart Business spoke with Hutter about problems with the rollout of the ACA exchanges and how reform continues to affect businesses of all sizes.
Should the 19 million people who were told their coverage was terminated have been surprised?
That was known back in 2010; it was written about. Plans were cancelled because the ACA changed requirements for insurers and the plans they provide. Plans are not only registered on a federal level but also on a state-by-state basis. Each state has a department of insurance to oversee plans and rate structures. A carrier needs to meet new requirements under ACA and state mandates, but when a plan design is changed, it is no longer grandfathered. It has to be terminated or withdrawn, and a new plan is submitted and approved. Whether this will be true going forward is uncertain.
If you are self-insured, the opportunity to keep the same plan is greater. Companies that self-insure can continue their plans as long as they don’t make significant changes.
Are self-insurance plans exempt from many ACA requirements?
Yes, that’s why companies have been exploring the option of self-funding arrangements. It’s a strange set of rules, but you can choose to cover or not cover certain things as long as they aren’t considered minimum essential coverage requirements. However, you can’t do it in a limited way; you can’t decide to cover autism, but only up to $10,000 a year. You have to choose to not cover it or cover it completely.
What self-funding does is create more predictability for companies because they purchase a stop-loss policy to limit their liability. Health insurance costs will continue to rise because of an aging demographic. The plan design can help keep increases to 4 to 6 percent annually instead of 30 or 40 percent.
Is that option also available to small businesses with fewer than 50 employees?
It can be, although you can’t do it like a big company would because a small employer doesn’t have the numbers to mitigate the risk of large claims.
Self-insurance is a design plan issue. Being self-insured with a specific stop-loss point might work. If you have 30 employees, you can have a stop-loss of $10,000 each. Then you need to figure out your actuarial funding for it and reserve that amount to pay for claims and expected losses. If you have a healthy group, it makes sense.
Small businesses also can join a pool for health insurance. That’s a service HR consultants or chambers of commerce provide, through an aggregation model, for clients or members to get health care. They don’t provide health care but establish a contractual arrangement with a company that does.
But the problem with the ACA is that new information is coming so quickly, and it takes months to rethink your health insurance strategy. This will continue to be difficult for companies to work through. ●
Insights HR Outsourcing is brought to you by Sequent
Rules added through the Jumpstart Our Business Startups Act eliminate the prohibition on using advertising and general solicitation to court investors to buy securities in certain unregistered offerings. While this has created possibilities, it has also imposed conditions.
The Securities and Exchange Commission (SEC) requires companies that generally solicit investors to take “reasonable steps” to verify that all purchasers in the offering are accredited. But there’s no bright line test to verify accreditation, says Michael Lawhead, an attorney at Stradling Yocca Carlson & Rauth. “Reasonable steps” are objective determinations made by the company in the context of each offering and each buyer. The SEC has, however, provided vague, but important, guidelines.
Smart Business spoke with Lawhead about vetting investors.
How should companies conduct due diligence on potential private investors?
For an individual to be accredited, he or she must have an individual net worth, or joint net worth with spouse, of $1 million annually, excluding the value of the investor’s primary residence. The investor’s individual income must exceed $200,000 in each of the past two years, or $300,000 in the past two years with a spouse, and have a reasonable expectation of reaching that in the coming years. One way to verify income is to examine the two most recent years of IRS reported income, which can be obtained from the individual. Certification from the individual about future income is acceptable.
To verify net worth, look at bank statements, brokerage statements or similar documents that would show net worth for the past three months. Companies should also acquire written representation from the individual that discloses his or her liabilities.
A company could also obtain written confirmation from a registered broker/dealer or other service provider who can verify the purchaser is accredited.
A certification of accredited investor status can be obtained from an individual who invested in the company’s 506(b) offerings prior to this new rule being enacted.
What constitutes reasonable steps?
The SEC has laid out three factors companies should explore to qualify investors. One factor is the nature of the investor. Public information can be used to qualify investment companies, such as venture capital funds. Qualifying individual investors can be done by attaching a high minimum investment amount to the offering. A company could conclude that the buyer is accredited if he or she can pay it.
Another factor is the type of information available. Public filings and information from reliable third parties can be used.
The last factor is the nature of the offering. Investors gathered by third parties, such as placement agents, are likely to be accredited since the third party has screened them.
What’s a ‘bad actor’?
Essentially, a company will not be able to rely on Rule 506 if certain covered persons purchasing securities have been subject to disqualifying events.
Covered persons include the company making the offering, its predecessors, affiliates, shareholders invested at 20 percent or greater, directors and officers, and any person who has or will receive compensation in connection with the offering.
The list of disqualifying events includes criminal convictions, court injunctions and restraining orders in connection with securities offerings.
Companies are looking to law firms to develop questionnaires to investigate individuals. If using a placement agent, verify the agency has done due diligence.
What happens if there’s an oversight in the verification process?
A company won’t lose the benefit of the 506 safe harbor as long as it can demonstrate that it attempted a thorough investigation of potential investors. Not following the steps results in the loss of the safe harbor, but not the ability to conduct a private offering.
General solicitation is not as easy as placing ads and waiting for money to roll in. The burden of complying with these rules is the responsibility of the company making the offering. An improperly conducted private offering could, among other things, give investors a right of rescission, which means they could take their money back. ●
Insights Legal Affairs is brought to you by Stradling Yocca Carlson & Rauth
International expansion is a great way to grow as the U.S. economy slowly recovers, and the population and per capita gross domestic product of countries such as India and China continue to rise.
But finding funding for exports can be difficult, unless you leverage a government-backed program.
“Why turn away sales when you can get working capital assistance through government programs to penetrate red-hot foreign markets?” says Alfred Ho, vice president and enhanced credit specialist with California Bank & Trust.
Smart Business spoke with Ho about the benefits of leveraging guaranteed export financing.
What is the working capital guarantee program?
U.S. manufacturers were struggling to compete overseas, as foreign sales and receivables are generally excluded from traditional lending programs.
So, to spur exports and domestic hiring, the federal government offers guaranteed financing programs administered by the U.S. Small Business Administration (SBA) and the Export-Import Bank of the United States (Ex-Im Bank).
The loan proceeds under these programs can be used to purchase supplies and equipment, hire staff or, in the case of the SBA’s Export Express program, even attend an overseas trade show.
And because the terms are flexible, owners can use the loan proceeds to fulfill a large contract or several small deals.
How do the programs help small businesses?
The programs encourage banks to lend to small businesses by guaranteeing 90 percent of the loan amount and allow loan officers to consider foreign receivables and work-in-progress during the underwriting process.
Plus, if a standby letter of credit is required to support a bid bond, advance payment guarantee or performance bond, the collateral requirement to have one issued is only 25 percent, instead of the 100 percent in traditional cases. This provides an edge for a U.S. company in its quest for overseas contracts.
How much can companies borrow and what does it cost?
The SBA Export Working Capital program permits loans below $5 million. It charges an upfront fee of 0.25 percent of the loan amount and an annual utilization fee of 0.55 percent, which is assessed monthly.
There’s no limit to how much you can borrow from Ex-Im Bank, and its upfront fees range from 1 to 1.5 percent of the loan amount. The loan interest rate is based on the prime lending rate plus a spread. Interest rates for larger loans are based on the London Interbank Offered Rate.
What are the eligibility requirements?
Requirements differ among the programs but they all require a firm purchase order prior to advance and, minimally, shipment from a U.S. port to a country acceptable to Ex-Im Bank. Goods and services shipped must have at least 51 percent U.S. contents.
Certain products are excluded from the programs. A company must also have a positive net worth and be profitable for the last three years to qualify.
For other qualifications and restrictions, talk to your lender or visit the SBA or Ex-Im Bank websites.
How can business owners find a participating lender?
Your local SBA or Ex-Im Bank representative can provide referrals, but you can look for a Delegated Authority lender who has the ability to expedite your loan.
Your banker can walk you through the lending process and share helpful ideas. The banker should be able to suggest ways to lower the risk of international commerce.
The important thing is: Don’t venture into the international marketplace alone. Find a competent banker to serve as your guide. ●
Insights Banking & Finance is brought to you by California Bank & Trust
Momentous Insurance Brokerage: How a personal umbrella policy adds an extra layer of liability protectionWritten by Jayne Gest
In today’s litigious society, people are filing more lawsuits and receiving larger judgments. Everyone needs to consider buying umbrella or excess liability insurance to protect their current and future assets against catastrophic loss.
“It is a financially sound idea for everybody to consider it, regardless of personal asset holdings,” says Erin Powers, CIC, assistant vice president at Momentous Insurance Brokerage, Inc. “The worst feeling is finding out at claim time that you could have had more protection if you had spent the extra few hundred dollars on an umbrella policy.”
Smart Business spoke with Powers about how to protect yourself with a personal umbrella policy.
Who needs to buy umbrella insurance?
Anyone with auto, homeowners or any other type of liability policy should consider umbrella insurance. We’re all exposed to claims and lawsuits that could jeopardize our current and future assets. An umbrella policy can protect against catastrophic (multi-million dollar) liability settlements.
Let’s say your dog bites a surgeon’s hand so severely he can no longer perform his job. Not only will the liability coverage pay for his medical costs, but it will also pay for his loss of wages. An umbrella policy will respond if your 16-year-old daughter crashes into a school bus, injuring or killing children, or if you injure someone with a golf ball. Another benefit of most umbrella policies is that there is coverage for legal defense costs outside of the excess liability limit.
Most auto and home carriers write no more than $500,000 or $1 million liability limits. An umbrella policy provides an additional layer of liability protection. Policy limits begin at $1 million and may be increased in increments of $1 million.
Is an umbrella the same as excess liability?
Umbrella and excess both provide additional coverage in excess of primary, but a true umbrella picks up exposures from the first dollar when no underlying insurance exists. Excess liability simply provides additional liability limits; coverage is not broadened. Many policies are called umbrella, but the contract wording says otherwise. Take time to understand what you’re buying.
What policy nuances are important to know?
The umbrella carrier will require you to maintain certain primary limits before triggering coverage. You’ll also want defense coverage to be outside of the limit of insurance, so defense costs won’t erode your limit. In addition, make sure you have worldwide coverage — some policies restrict coverage to the U.S. Family trusts or LLCs that own any tangible assets covered on the primary policies need to be included on the umbrella policy as the trust and/or LLC can be brought into the lawsuit.
Personal injury is also an important component to include. It covers things beyond bodily injuries, such as defamation of character, libel, slander, false arrest, wrongful eviction and violation of the right of privacy. With social media, everybody is putting opinions in writing. It’s an important exposure to cover, although some policies are starting to restrict Internet coverage.
What endorsements can help enhance your umbrella?
Typically, if there’s a claim, the insurance company will provide an attorney. A shadow defense provides an extra limit to bring on your own attorney to consult.
Some umbrellas include, by endorsement, employment practices liability, which protects you if a domestic employee sues for discrimination, sexual harassment or wrongful termination.
Another enhancement to consider is uninsured motorist coverage. A few companies can also include uninsured personal liability. With these coverages, you get the benefit of having your medical expenses paid, if the person who causes injury has inadequate or no liability coverage.
How do you know how much to buy?
Certain people are more at risk. Assess your lifestyle and re-evaluate with life changes. What kinds of things do you have, and what could potentially happen? Do you have parties at your house? Are you in the public eye? Do you have kids who are driving? Do you have a swimming pool?
Determining the proper limit is not an exact science. You can’t measure liability loss like a property loss. You want enough coverage to protect your assets, and maybe a little extra for peace of mind. ●
Insights Business Insurance is brought to you by Momentous Insurance Brokerage, Inc.
The world of business today goes beyond the U.S. borders, so executive education programs like MBAs have a global component. For example, Woodbury University is part of a customized MBA program through the newly formed Carl Benz Academy for employees of Mercedes Benz and its affiliate companies.
Andre van Niekerk, Ph.D., dean of the School of Business at Woodbury University, says the program specifically serves employees in the luxury brand segment in emerging markets.
“There’s always a market for high-end brands, and that fully applies to the developing world,” he says.
Smart Business spoke with van Niekerk about the challenges and opportunities in marketing luxury brands in the world’s emerging economies.
Given the uneven recovery from the global recession, how open to luxury brands are today’s developing economies?
Virtually all luxury brands are jumping, or have jumped, into the developing world. That market — that collection of economies — is reaching a near-saturation point for some. To a large degree, it’s a matter of numbers; the size of the individual markets is key. If millionaires represent 3 percent of the population of China, for example, companies will pay attention.
Of course, if you step back and ask, ‘what is luxury?’ Your immediate response might be that people who have very little define luxury. In some parts of the world, two meals a day would be considered a luxury. There’s clearly a different context in the developing world, when contrasted with the developed world.
Having said that, however, luxury brands appeal to similar demographics worldwide. The people who buy and consume what are generally recognized as luxury goods, from clothes to jewelry to cars, are simply not as affected by economic downturns as the rest of the population. There’s just less price sensitivity.
Combined with quality and aesthetics, exclusivity is central to marketing a luxury brand. But the richer the world gets, the tougher it is to keep that exclusivity. Brands can artificially impose exclusivity by raising prices. Price, therefore, confers status — the status the brand affords the consumer. It’s an implied status, creating a desire to move up. The challenge for manufacturers is to keep customers brand loyal, wherever in the world they may be.
How do cultural differences come into play, as manufacturers introduce products and develop strategies to market them?
While many recognized luxury brands have a genuine global reach and can be considered universal, local tastes and accepted local norms matter. A specific handbag may become a roaring success in the U.S. but may not be as desirable in China. Or a specific color popular in Western Europe may not resonate somewhere else. Cultural nuances are often reflected in advertising, and it’s common for brands to reword and reposition ads for each market. Some nuances simply can’t be transplanted.
Status exists in every culture, and everyone has an ego, but the drivers for status differ across cultures. The U.S. is largely externally driven, as places like Newport Beach, Rodeo Drive or the Chicago Loop suggest. Other cultures are very circumspect — you don’t wear status on your sleeve.
What impact has the proliferation of luxury brands in the developing world had on those same brands in the developed world?
That trend has given rise to knockoffs. Counterfeit goods pose a huge problem for luxury brands, especially when the population at large may not be knowledgeable about what’s real and what’s fake. Knockoffs can ruin the brand by association. That’s why manufacturers confiscate and prosecute — they actively pay for that vigilance.
Things may be changing on this front, however. In a deal with China, Ralph Lauren agreed to overproduce by approximately 4 percent. Local merchants are allowed to sell the overproduction in controlled outlets at a slightly lower price. It’s a total win — a way to spread the brand successfully and locally, while helping to undercut the market for counterfeit merchandise. ●
Insights Executive Education is brought to you by Woodbury University
The Jumpstart Our Business Startups Act (JOBS), passed in early 2012, mandates that the Securities and Exchange Commission (SEC) adopt rules to help start-ups and small businesses raise capital. Because of this, companies can advertise, market and publicly disclose that they are fundraising. The change also allows companies to raise up to $1 million from a large number of “nonaccredited,” or non-high net worth investors.
Smart Business spoke with Mark L. Skaist, shareholder and co-chair, Corporate and Securities Practice, at Stradling Yocca Carlson & Rauth about what this could mean for businesses.
Why does it matter that companies can advertise that they’re fundraising?
Companies need to either register their securities offering with the SEC or find an exemption from registration. Registration is often prohibitively expensive for start-ups, so most emerging companies rely on an exemption from registration, the most common of which is Rule 506 under Regulation D. This permits sales of an unlimited dollar amount of securities to an unlimited number of accredited investors and up to 35 nonaccredited investors.
However, in order to rely on this exemption, companies had been prohibited from offering or selling securities through any form of general solicitation or general advertisements.
By allowing companies to advertise their securities offerings to the general public, companies should have a bigger pool from which to solicit investments.
There are, however, two conditions companies must meet in order to use general solicitation and advertisement and sell securities under Rule 506. Namely, all purchasers in the offering must be accredited, which for natural persons generally means net worth in excess of $1 million, or annual income of at least $200,000. Also, the company must take ‘reasonable steps’ to verify that the purchasers are accredited.
How are companies supposed to verify that a purchaser is accredited?
The SEC has said that companies need to make an objective determination in the context of the given facts and circumstances. It has come out with a nonexclusive list of verification methods that can be considered ‘reasonable steps.’ The specific methods and types of information the SEC considers sufficient include written representations of investors combined with two years of federal tax returns; bank statements combined with credit reports; and written confirmation from a broker, attorney, investment adviser or accountant.
How are the proposed rules regarding crowdfunding supposed to work?
These proposed rules provide that companies may sell up to $1 million of securities during any 12-month period to accredited and unaccredited investors. They also limit annual crowdfunding investments by investors with annual income or net worth below $100,000 to the greater of $2,000 or 5 percent of the investor’s annual income or net worth. For investors with annual income or net worth in excess of $100,000, annual crowdfunding investments cannot exceed 10 percent of their annual income or net worth.
There are also proposed initial and annual filing requirements by the company doing crowdfunding financing, which may include financial statements, a business plan and tax returns. Companies can use intermediaries, such as brokers and funding portals, and may not advertise the offering other than to provide a notice directing potential investors to the intermediary.
Based on the proposed rules, which require that companies raising between $100,000 and $500,000 through crowdfunding provide reviewed financials, and companies raising more than $500,000 provide audited financials, it’s likely that the accounting fees alone are going to be a significant roadblock to many small companies relying on this exemption.
While it seems steps have been taken toward making it easier for start-ups and emerging companies to raise money, time will tell whether they have any real impact. In the meantime, businesses are popping up that are looking to get involved with these types of offerings, either by verifying that investors are accredited or by setting up funding portals for crowdfunding. ●
Insights Legal Affairs is brought to you by Stradling Yocca Carlson & Rauth
In 2012, the energy sector spent $17.9 billion on global research and development, more than $6.6 billion of which was conducted in the U.S. Assuming small and midsize businesses perform 20 percent of the U.S. energy sector’s R&D, these companies could incur up to $1.3 billion in R&D expenditures, the benefits of which may not be fully realized because they underutilize the R&D tax credit, says Robert Henry, a partner in Tax and Strategic Business Services at Weaver.
In addition, the R&D tax credit represents a permanent tax benefit; it reduces the overall effective tax rate as presented in generally accepted accounting principles basis financial statements.
Smart Business spoke with Henry about new ways to utilize R&D tax credits.
What is the R&D credit?
The federal R&D tax credit is a mechanism to spur technological advances and hiring in R&D fields. It has expired and been extended multiple times, but has most recently been extended through 2013. With support in both political parties, it is likely to be continued.
In addition, many states offer R&D tax incentives in the form of state income, franchise, or sales and use tax credits and exemptions. Texas’s R&D credit will come back into law effective Jan. 1, 2014. Texas HB 800 provides a sales and use tax exemption or a franchise tax credit related to qualified R&D activities taking place within Texas. This will greatly increase the potential tax benefit available to taxpayers conducting their R&D within Texas.
How is qualifying R&D activity defined?
Internal Revenue Code section 174 describes research and experimental expenditures as activities intended to discover information that will eliminate uncertainty concerning the development or improvement of a product. The activity must:
- Be related to the development or improvement of a product, inclusive of a technique, invention, formula or process.
- Address uncertainty regarding the appropriate method or design for the product.
Activities deemed eligible by section 174 qualify for immediate tax deduction. They also may qualify under section 41, where they must:
- Be technological in nature, based in hard sciences, such as geology or engineering.
- Contain a sufficient degree of development uncertainty.
- Contain the process of experimentation.
- Have a permitted purpose that improves a business component, which includes a product, process, software, technique, formula or invention.
What oil and gas activities may qualify?
‘Wildcat’ exploration, the drilling of a well, the development of logistical infrastructure — really the entire exploration and production process — may qualify for the R&D credit. That also includes improved analytics and software that enables more accurate interpretation of reservoir studies. A pipeline company in the industry’s midstream sector may be more efficiently monitoring flows of oil and natural gas or overcoming adverse field conditions in placing a pipeline. Downstream companies may benefit from improved processes for purifying or refining natural gas or oil.
What costs are eligible for the credit?
Wages for employees engaging in qualified research, directly supervising qualified research or supporting it are eligible. A company may also deduct 65 percent of contract labor costs associated with qualifying R&D activities.
Tangible property costs used in the R&D process or in the construction of a prototype can be qualifying expenditures. Supply expenses, though, cannot include land or land improvements, or property subject to depreciation. Expenses for royalties, shipping or travel also cannot be included. In addition, special considerations apply for internal-use software.
In order to capture all eligible credit when R&D activities are identified, companies must track and record labor costs of internal employees, contractor and vendor expenses, and supplies or materials costs. A business that is aware of the manner in which these costs are tracked and accounted for will more accurately define what it can claim for an R&D tax credit. ●
Insights Accounting is brought to you by Weaver
Cloud computing has grown in popularity because it can help boost productivity and reduce costs by allowing organizations and employees to work collaboratively over the Internet from the office and remote locations.
But that ease of access to your business applications and data brings increased risk.
“Cloud computing presents a number of risks, ranging from data leakage to cyberattacks on cloud computing vendors and their customers,” says Jim Stempak, a principal at Crowe Horwath LLP.
Smart Business spoke with Stempak about a methodology to periodically assess cloud computing IT security risks.
What risks are associated with cloud computing?
Whether you sign up for software as a service (SaaS), platform as a service (PaaS), infrastructure as a service (IaaS) or some combination of service models, your organization is exposed to risk because security is applied differently than in traditional noncloud IT environments. Additionally, your vendor might not have security standards on par with your own.
Some areas of risk are:
- Cloud governance risk. Cloud governance refers to controls and processes for cloud planning and strategy, vendor selection, contract negotiation, implementation, operation and possible termination of service. Some companies rush into cloud computing and don’t properly assess risks and implement controls to mitigate them.
- Weak identity and access management controls. Moving to the cloud can drastically change how customers control access to accounts and computing resources, thus introducing new security risks.
- Unsecured data connections. With the cloud, much of the data communication takes place outside of your IT environment. It’s important to understand where your data is and assess vendor protection of data in transport and storage.
- Workforce security risk. Often employees use personal cloud storage services such as Dropbox, Evernote, Google Apps, SkyDrive and iCloud to transfer and store work-related files without authorization or oversight from IT management. A recent Nasuni Corp. survey of 1,300 corporate IT users found one in five respondents put work files in personal Dropbox accounts. Personal cloud storage services lack enterprise-class security protection, and, in turn, could put sensitive data at risk and increase the chance your organization is noncompliant with industry and government standards.
How should a company assess its cloud security risks?
Companies should review all layers of risk associated with the specific use of cloud services in their IT environment. Start with a review of common controls, including cloud governance, identity and access management, and transmission security. A corporate cloud security assessment typically focuses on controls affecting cloud governance, such as cloud planning and strategy, vendor selection, implementation, termination and transition of cloud services; identity and access management, such as account setup, level of access and single sign-on; and secure connectivity, such as encryption, backup plans, logging and monitoring.
You also need to conduct a workforce assessment to identify unauthorized use of personal cloud services, which includes:
- Network scanning — special software applications scan networks for the most popular services for storing and transferring data in the cloud.
- Passive monitoring — applications track network traffic to uncover connections with website addresses associated with personal cloud services.
- Log analysis — servers have log files that capture useful data about network activity to help pinpoint cloud services traffic.
- Workforce survey — ask if employees are using personal cloud services for work and why. This can help you understand cloud service needs and identify potential risks.
Cloud computing changes the way people work and is here to stay. Organizations need to completely understand how they are using cloud services — in both known and unknown ways — before valuable data winds up in the wrong hands. ●
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