Weaver: How oil and gas companies can capture overlooked R&D tax credits

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.

Robert Henry, CPA, is a partner in Tax and Strategic Business Services at Weaver. Reach him at (800) 332-7952 or [email protected].

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Weaver: How forensic accountants and the public sector combat fraud

The vast amount of public funds and programs in federal, state and local governments can make it difficult to keep track of expenditures. Far too many people seize this opportunity to commit fraud, which in turn halts intended improvements or services.

For example, the Houston-based Dubuis Health System and Southern Crescent Hospital for Specialty Care Inc., in Riverdale, Ga., were accused of overcharging Medicare. The hospitals allegedly hospitalized patients longer than necessary to obtain larger reimbursements from the government. They agreed to repay the U.S. government $8 million to resolve various False Claims Act (FCA) allegations dating back to 2003.

“When fraud involving public funds occurs, the amount of goods or services those funds can purchase diminishes, and taxpayer dollars are wasted. Constituents see declining value. Public officials and stakeholders face questions regarding the use of tax dollars or other people’s money,” says Trish Fritsche, a senior manager in Forensics and Litigation Services at Weaver.

Smart Business spoke with Fritsche about how public sector officials and other stakeholders can respond to fraud schemes with the help of forensic accountants.

What are the most prevalent fraud methods used in the public sector?

Common ways to divert public funds from intended use are asset misappropriation, corruption and financial statement fraud. Although internal controls can be put in place to prevent fraud, in reality, fraud is potentially as unlimited as the human ingenuity to circumvent those controls.

How should organizations respond?

Once an incident of suspected fraud is identified via a hotline or other source, questions to ask include:

  • Should the investigation be handled internally or externally?
  • Who are the stakeholders?
  • What are the resources needed?
  • Should the entity self-report fraud?

At this time, attorneys and forensic accountants may need to become involved. Forensic accountants possess the skills necessary to appropriately respond in a crisis. They understand how to discover and develop information that can be used by governmental entities, boards and others with fiduciary responsibility. Forensic accountants also provide consulting services or expert testimony. They work closely with law enforcement and others to properly address the fraudulent conduct.

What laws can assist with addressing fraudulent conduct?

The Fraud Enforcement and Recovery Act of 2009 (FERA), enacted just after the American Recovery and Reinvestment Act, seeks to reduce fraud involving federal money and property. The act expanded various civil and criminal fraud statutes to include mortgage businesses, as well as entities associated with recovery act funding.

Liability under the FCA was originally limited to individuals or entities that directly or indirectly induced payment by the federal government. FERA, however, expanded that. Now, the FCA not only applies to direct recipients of government funds, but also to any contractor or other entity receiving funds. It explicitly prohibits the retention of government overpayments to individuals or entities.

The Racketeer Influenced and Corrupt Organizations Act (RICO) was enacted in 1970 to combat organized-crime activities. It has since been used to prosecute other offenses, including fraud cases involving government funds. Under RICO, anyone who has committed any two crimes from a list of 27 federal and eight state crimes —such as bribery, embezzlement and money laundering — within a 10-year period can be charged with racketeering. RICO allows a U.S. Attorney to temporarily seize a defendant’s assets and prevent the transfer of potentially forfeitable property. In addition, private parties are allowed to file civil lawsuits under certain circumstances.

Each fraudulent act involving public sector funds not only decreases the funds available, it also causes constituents to lose faith in officials. Effectively combatting fraud enables entities to do the greatest good for the greatest number, while establishing trust among all stakeholders.

Trish Fritsche, CPA, CFF, CITP, CGMA, is a senior manager in Forensics and Litigation Services at Weaver. Reach her at (800) 332-7952 or [email protected].

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Weaver: What companies can do in the final months of 2013 to save on their tax bills

The government has increased tax rates and implemented other changes for 2013. However, companies may be able to employ tax-saving options — deductions, depreciation provisions or deferrals — prior to Dec. 31.

If companies review before year-end, they are better able to maximize potential savings, and it may even spur thoughts for future tax planning, says Sean Muller, partner-in-charge, Houston Tax and Strategic Business Services at Weaver

Smart Business spoke with Muller about the opportunities to save on your 2013 taxes.

How can businesses utilize enhanced Section 179 deduction limits in 2013?

Enhanced Section 179 deduction limits were enacted for 2013, which allow companies to immediately deduct up to $500,000 of equipment purchases made, rather than depreciating over a number of years.

The deduction applies to 2013 equipment purchases of up to $2 million. The deduction is slowly phased out for taxpayers with $2.5 million or more in purchases. Section 179 deductions can be applied toward tangible property purchases, but real property doesn’t qualify. 

In 2014, the Section 179 limitation will decrease to $25,000. Companies that plan to make large capital expenditures in 2014 may wish to purchase in 2013 instead. The deduction can be used to reduce tax liability to zero, but it cannot put you in a net loss position.

How does bonus depreciation differ? 

Taxpayers in some states may be able to utilize a 50 percent bonus depreciation rate for qualified property placed in service during 2013. Unlike the Section 179 deduction, bonus depreciation is not limited to net income and does not limit the deduction amount.  

Bonus depreciation applies to new, original use U.S.-based property with a recovery period of 20 years or less.

The 50 percent bonus depreciation and Section 179 deduction can be used together.

What savings are available through like-kind exchanges?

Another tax-saving opportunity to consider is like-kind exchanges. IRS Code Section 1031 enables a taxpayer to defer capital gains tax if the property sale proceeds are reinvested in similar property within a relatively short time. The exchange may be a simultaneous swap of properties or a deferred exchange. With a deferred exchange, one property is disposed of and the proceeds are then used to buy one or more like-kind properties. 

Section 1031 exchanges exclude inventory, stocks, bonds and partnership interests. 

Who can take domestic production activity deductions (Section 199)?

In 2013, businesses with qualified domestic production activities may be able to receive a 9 percent tax deduction. Qualifying activities include the manufacture, production, growth or extraction of qualifying production property within the U.S., as well as real property construction, oil and gas drilling, and engineering and architectural services related to real property construction. 

Generally, a taxpayer is allowed a deduction equal to the lesser of: 

  • Qualified production activity income (QPAI), which is a modified calculation of income related to qualifying production activities.
  • Taxable income.
  • 50 percent of the form W-2 wages deducted in arriving at QPAI.

The level of complexity in calculating the appropriate deduction depends on the nature and structure of the business. 

What are other year-end tax strategies?

Companies also should consider potential residual tax-saving activities, such as:

  • Deferring income to 2014 if cash flow and current income permit.
  • Making additional charitable donations. 
  • Writing off and disposing of damaged or obsolete inventory to reduce carrying costs and garner tax deductions.
  • Writing off bad debt that cannot be collected. Companies should keep supporting material like phone logs, correspondence, collection agency contracts, etc., to prove a reasonable effort was made to collect.

Invest the time now to plan for your 2013 taxes and reap the benefits later. 

Sean Muller is partner-in-charge, Houston Tax and Strategic Business Services, at Weaver. Reach him at (832) 320-3293 or [email protected].

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How to encourage internal reporting of fraud or misconduct

In July, the 5th U.S. Court of Appeals ruled in Asadi v. G.E. Energy (USA) LLC that whistle-blowers aren’t entitled to protection under the Dodd-Frank Act’s anti-retaliation provision unless they report directly to the Securities and Exchange Commission (SEC).

This ruling — currently limited to Texas, Louisiana and Mississippi — may provide incentive to bypass the internal process for reporting suspected fraud or misconduct.

When going directly to the SEC, employees not only get monetary awards for information that leads to successful enforcement actions but also have the assurance of protection against retaliation, says Carolyn Bremer, senior manager in Forensic and Litigation Services at Weaver.

“Already, many companies are struggling to keep internal compliance programs strong, actively looking for ways to encourage employees to utilize their internal reporting processes,” she says.

Smart Business spoke with Bremer about how to instill trust in your internal compliance program in the Dodd-Frank era.

What has been the impact of Dodd-Frank on whistle-blower reporting to the SEC?

According to its annual report on the Dodd-Frank Whistleblower Program for fiscal 2012, the SEC received 3,001 whistle-blower tips and awarded a second whistle-blower award this past June. There may be an uptick in tips because of the announcement of these recent monetary awards, the expected increase in future awards and the court ruling.

Why do employees hesitate to internally report fraud or suspected misconduct?

Employees often hesitate because of bad experiences either personally or from co-workers’ stories. Reasons for not reporting potential fraud or misconduct include the fear of not remaining anonymous, fear that no one will believe them, or fear of retaliation such as losing their job, not receiving a raise or being demoted. They also fear discrimination or isolation from co-workers, or sense that the tone at the top doesn’t support the policies.

What can be done to alleviate hesitation?

A company can instill trust in reporting internally by focusing on strengthening its hotline process and whistle-blower policy.

Your hotline must provide a way to report in confidence, while being monitored by an appropriate party. Avoid having tips go directly to human resources or management. Employees should see the monitor as more independent — such as in-house counsel, head of internal audit or a compliance officer — especially if they fear retaliation.

Ensure there are clearly defined timelines or checkpoints for follow up, which include communicating back to the whistle-blower that the tip is being handled discreetly and the issue is being addressed appropriately.
Have a documented whistle-blower policy that addresses retaliation protection. What is considered retaliation and the penalties for it should be clearly outlined. For example, ‘harassment or victimization for reporting concerns under this policy will not be tolerated’ is insufficient. A better statement is: ‘No employee who in good faith reports a violation of the code of conduct or potential fraud or misconduct shall suffer harassment, retaliation or adverse employment consequences. An employee who retaliates against someone who reported in good faith is subject to discipline up to and including termination of employment.’

By voluntarily extending the whistle-blower protections afforded under Dodd-Frank to all employees who report internally, companies introduce additional trust.

Why is it important that employees feel comfortable reporting matters internally?  

In bypassing internal compliance, employees deprive the company of the opportunity to investigate and remedy a wrongdoing before regulators get involved. Many tips don’t warrant the SEC’s attention but do warrant corrective action or communication within the company. However, management can’t address a problem they don’t know about.

Nevertheless, there are obvious instances that warrant direct reporting to the SEC, and it’s always advisable for employees to seek legal advice when deciding whether to report internally or externally.
Strengthening your hotline process and whistle-blower policy, and educating your employees, can be key to instilling trust in internal whistle-blower reporting.

Carolyn Bremer is senior manager of Forensic and Litigation Services at Weaver. Reach her at (972) 448-6951 or [email protected].

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