National news has been filled of late with word that the 112th Congress has avoided the dreaded “Fiscal Cliff” by passing the American Taxpayer Relief Act or 2012 (H.R.8). However, with new legislation comes new questions: “How does this apply to me? What does this mean to my business?” The following article outlines, in brief, some of the changes included in the new legislation and the effect those changes will have on businesses.
Most of the legislation passed simply extended tax credits and other incentives that were set to expire at the end of 2011. Overall, very few of the tax credits were changed at all. For example, section 309 of H.R.8 deals with the Work Opportunity Tax Credit (WOTC). Per section 309 of the new legislation, WOTC has been extended to the end of 2013 including a retroactive extension to all of 2012. As stated by the U.S. Department of Labor, WOTC (codified at I.R.C. § 51) is a “Federal tax credit available to employers for hiring individuals from certain target groups who have consistently faced significant barriers to employment.”[
While tax credits like WOTC were simply extended without any changes, some tax incentives were impacted by changes to other areas of legislation. For example, the adjustment to the capital gains rate contained with H.R.8 indirectly impacts the Interest-Charge Domestic International Sales Corporation (IC-DISC) tax incentive. The IC-DISC tax incentive allows businesses the opportunity to take advantage of the more favorable capital gains tax rate for a certain percentage of export income rather than the usual ordinary income tax rate. Under the old tax regime, the maximum ordinary income tax rate was 35% but the qualified dividend rate, which was directly tied to the capital gains tax rate, was only 15%. Because businesses were allowed to apply the 15% tax rate to a certain percentage of export income, rather than the 35% tax rate, an IC-DISC represented huge, potential tax-savings for export companies.
Under the new legislation, taxpayers utilizing an IC-DISC will still be able to take advantage of the lower capital gains tax rate for a certain percentage of export income but, per section 102 of H.R.8, the capital gains tax rate will be increased to 20%, thus increasing the rate at which qualified dividends are taxed. Since the maximum ordinary income tax rate is being increased to 39.6% (Section 101(b)(3)(A))
Still other tax credits, like the Credit for Increasing Research and Development (the R&D credit), were not only extended but also given substantive changes and clarifications (H.R.8 section 301). Section 301(a) of the new legislation officially extended the R&D tax credit (set to expire December 31st of 2011) to the end of 2013 and made it retroactively effective for 2012. While the majority of the credit calculation itself remains the same, a few, key modifications were made.
One modification was a slight change in the wording regarding the aggregation of expenditures. Section 301(c) speaks to the way that qualified research expenses (QREs) used to calculate the R&D credit should be apportioned between brother-sister or parent-child controlled groups. The change clarified that the proportionate shares of QREs that are to be apportioned that were formerly referred to as “giving rise to the credit” are, in fact the QREs “taken into account by such controlled group for purposes of this section” (H.R.8 section 301(c)(1)) and “taken into account by all such persons under common control for purposes of this section” (H.R.8 section 301(c)(2)). Zee Makhani, Director at Paradigm Partners, commented, “Really, there is no substantive change here. The changes in wording just clarify what we already knew about how QREs are supposed to be apportioned in reference to a controlled group.”
The more substantive changes made to the R&D credit relate to the treatment of new acquisitions. The R&D credit is calculated using a comparison of QREs in the current year to QREs from relevant base years. The base years vary depending on the method of calculation used (i.e. “Regular Credit” or “Alternative Simplified Credit” (ASC)). Using ASC, for example, the base amount is calculated as 20% of the average QREs of the previous three years. In general, as the base amount increases in relationship to the current year QREs, the R&D credit decreases.
Congress has realized the benefit of many tax credits and has chosen to extend that benefit for at least another year. H.R.8 extended most of the tax credits set to expire without making substantive changes. Saqib Dhanani, Director at Paradigm Partners, was quoted as saying, “I think this is a very positive thing for small businesses and that Congress recognizes how beneficial credits and other tax incentives like the WOTC and IC-DISC are.” A few credits will be impacted by the new rate changes but they will still remain invaluable tools for business owners in the coming years. Finally, the few substantive changes that were made mostly apply to very narrow situations and generally have a positive effect on taxpayers. Overall, it was a good day for Congress and a better day for American business owners.
About the Authors:
The authors are Saqib Dhanani, Attorney at Law and Rebecca Icenogle, Attorney at Law both of Paradigm Partners. Paradigm Partners is a national consulting firm specializing in complex federal and state tax and funding incentives, for both public and private entities, across a host of industries. The Company’s core consulting portfolio includes R&D Tax Credits Analyses, Hiring and Location Tax Incentives, Grant and Non-dilutive Funding Advising, IC-DISC, Cost Segregation Studies, and Tax Controversy, Patent and Audit Defense Services. Saqib's email is SDhanani@ParadigmLP.com and his phone number is (281) 558-7100. Our website is www.ParadigmLP.com.