• The CHIPS Act provides more than $50 billion to boost U.S. semiconductor manufacturing, including current funding opportunities for commercial fabrication facilities and advanced packaging research and development (R&D).
• The Advanced Manufacturing Tax Credit (Section 48D) offers a 25% credit for qualified investments into semiconductor manufacturing facilities placed in service from 2023-2026.
• Companies seeking CHIPS incentives or 48D credit should understand eligibility requirements, review application process details, and connect with specialized tax credits and incentives professionals to ensure maximum benefit.

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On August 9, 2022, President Joe Biden signed into law the Creating Helpful Incentives to Produce Semiconductors Act of 2022 (commonly referred to as the CHIPS Act). The legislation provides $52.7 billion to increase semiconductor research and development in the United States. The CHIPS Act also established the Advanced Manufacturing Tax Credit (Section 48D), available to entities that manufacture semiconductors.

Recently, the government awarded its first major CHIPS Act grant – providing $1.5 billion to GlobalFoundries, one of the world’s leading semiconductor manufacturers, to expand its semiconductor production in New York and Vermont. That grant is expected to be the first of several announcements in the coming months as the government ramps up CHIPS Act funding.

What is the Purpose of the CHIPS Act?

The intent of CHIPS is simple: the U.S. wants to incentivize domestic companies to manufacture semiconductors. The president called the CHIPS Act a “once-in-a-generation investment in America itself,” as the legislation aims to lower costs and create jobs in the production of these advanced chips.

The COVID-19 pandemic forced the semiconductor industry to operate at a reduced capacity, while lockdowns increased demand for products using semiconductors (computers, tablets, gaming systems, cars, etc.). This created a perfect storm, fueling a shortage of semiconductors. As a result, the U.S. recognized the need to increase its semiconductor output.

However, manufacturing semiconductors is not cheap and requires substantial investments. CHIPS, along with the available tax credit, encourages these investments.  

The CHIPS Act includes provisions for:

• $39 billion in incentives to build, expand, or modernize domestic facilities and equipment for semiconductor manufacturing, assembly, testing, advanced packaging, or research and development
• $13.2 billion in R&D and workforce development
• $500 million for international information communications technology security and semiconductor supply chain activities

Understanding the Advanced Manufacturing Tax Credit

With the addition of Section 48D to the Internal Revenue Code, CHIPS offers a new tax credit if your company invests in advanced manufacturing facilities or facilities whose primary purpose is manufacturing semiconductors or semiconductor manufacturing equipment.

Eligible businesses can receive a 25% tax credit of “qualified investments”. You can elect to treat the credit as payment against tax (i.e., direct pay) if you do not have sufficient tax liability to utilize the credit, making this essentially a refundable tax credit.

Eligibility criteria for 48D

To be eligible for 48D, you must have made a qualified investment for any taxable year integral to an “advanced manufacturing facility” for semiconductors placed in service during that year. Qualified properties must be:

• Buildings, structural components, or parts of a building (not including administrative services or other functions unrelated to manufacturing)
• Crucial to the operation of the advanced manufacturing facility
• Constructed or built by the taxpayer
• Qualified for amortization or depreciation

Taxpayers that use facilities and equipment outside the U.S. will not be eligible (similar to other investment credit requirements). Other taxpayers ineligible for the credit include:

• Foreign entities noted as “foreign entities of concern” (i.e., foreign terrorist organizations or organizations included on the Office of Foreign Assets Control list).
• Taxpayers that have engaged in significant transactions involving the material expansion of semiconductor manufacturing capacity in China or another foreign country of concern.
• If a taxpayer enters a transaction in a foreign country of concern within 10 years of claiming the credit, it will be recaptured. 

48D timing

The tax credit applies to any property placed in service after December 31, 2022, for which construction begins before January 1, 2027. It does not apply after December 31, 2026, nor can you use the tax credit for constructing a property after this date. If construction on a facility began before January 1, 2023, the credit applies only to the portion of the construction started after August 9, 2022. 

Application process  

In March 2023, the IRS issued proposed regulations addressing direct payment of Section 48D credit. The proposed regulations also require taxpayers to register through an IRS electronic portal before treating Section 48D as a direct payment on a tax return.   

The IRS will issue a registration number for each qualified investment for which your company is claiming a credit, and that number must be included on your tax return. 

CHIPS Incentive Opportunities

To access CHIPS incentives, your company must first apply for open funding opportunities. To date, the U.S. Department of Commerce has issued three Notice of Funding Opportunities (NOFOs) through the CHIPS for America program: 

1. Commercial Fabrication Facilities – Currently accepting applicants  

2. Small-Scale Supplier Projects – No longer accepting applicants, in second phase of process 

3. National Advanced Packaging Manufacturing Program (NAPMP) Materials & Substrates – Just announced on February 28, 2024 

How to apply for open NOFOs 

Application forms and instructions are available on the CHIPS Incentives Program application portal. FAQs, guides, and templates can also be found in the “Resources” section of the portal. 

The application process includes the following stages: 

• Statement of interest 
• Pre-application (optional, but recommended) 
• Full application 
• Due diligence 
• Award preparation and issuance 

Statement of interest – To submit a statement of interest, applicants need to register for an account on the CHIPS Incentives Portal. A statement of interest must be submitted at least 21 days prior to submitting a pre-application or full application. 

Pre-application – The optional pre-application provides an opportunity to ensure your projects are consistent with program requirements. During this stage, you will receive feedback on strengths and weaknesses of your proposal and recommendations for improvement. 

Full application – Both pre-applications and full applications are accepted on a rolling basis. 

Due diligence – Your application will undergo review to ensure alignment with evaluation criteria specified in the Notice of Funding Opportunity (NOFO), with the possibility of requests for additional information. 

Award preparation and issuance – Before receiving an award, you must have an active registration in the System for Award Management (SAM). It’s a good idea to begin the registration process for SAM.gov early as it may take anywhere from two weeks to six months (due to information verification requirements). Check out SAM.gov’s Entity Registration Checklist. 

Maximizing Your Semiconductor Manufacturing Tax Credits and Incentives

Navigating CHIPS’s nuances can be challenging – especially when claiming the available tax credit and determining how it is refundable. Furthermore, companies seeking to increase their semiconductor manufacturing capacity in the U.S. should also assess application and opportunity for federal and state R&D tax credits and incentives.   

With more than 30 years of experience, our dedicated Tax Credits and Incentives team can help you maximize your credit benefits, develop the appropriate documentation methodology, assist in calculating and claiming credits, and defend your claims. Our full-service firm, led by experienced CPAs and attorneys, provides a holistic approach to examining your organization and determining how to best reach your goals.

• California now has a new tax credit called the High-Road Cannabis Tax Credit (HRCTC) available for eligible cannabis retailers and microbusinesses. 
• The credit is available for tax years starting after January 1, 2023, through December 31, 2027, and can be applied against current year (and future) income taxes.  
• To claim it, you must make a “tentative credit reservation.” 
• Expenditures that qualify include wages for full-time employees; safety-related equipment, training, and services; and workforce development and safety. 

While the cannabis industry in California has been struggling on many levels, tax credit relief has come in the form of excise tax changes for distributors and has now arrived for retailers. The High-Road Cannabis Tax Credit is a new tax credit from the California Franchise Tax Board (FTB) available for cannabis retailers or microbusinesses for taxable years beginning January 1, 2023, through December 31, 2027. In order to capitalize on this opportunity, eligible calendar-year taxpayers must make a tentative credit reservation during the month of July to claim the credit on their 2023 CA income tax return. 

Who qualifies for the HRCTC 

To be eligible, you would need to meet three basic requirements.

Which expenditures qualify for the HRCTC 

There are several types of expenditures eligible for the credit with specific parameters that you would need to meet to qualify for them. Qualified expenditures are amounts that you have paid or incurred for any of the following expenses. 

Wages for full-time employees

Not every employee has to meet these requirements — but for those that do, their wages count as a qualified expenditure. First, full-time employees must be paid for no less than an average of 35 hours per week — or they must be a salaried employee paid compensation for full-time employment. 

In addition, full-time employees must be paid no less than 150% ($23.25) but no more than 350% ($54.25) of the state minimum wage. To meet the 150% minimum wage requirement, you may include the following employee benefits in qualified wages: group health insurance, childcare support, employer contributions to employer-provided retirement plans, or contributions to employer-provided pension benefits. But if you pay employees wages that surpass more than 350% of the state minimum wage, those wages are not considered a qualified expenditure.  

Safety-related equipment, training, and services 

Expenditures related to safety, training, and providing services can also qualify if they meet the following criteria: 

• Equipment primarily used by the employees of the cannabis licensee to ensure personal and occupational safety, or the safety of the business’s customers. 
• Training for nonmanagement employees on workplace hazards. (This includes safety audits, security guards, security cameras, and fire risk mitigation.) 

Workforce development and safety  

Qualified training for your employees includes: 

• Joint labor management training programs 
• Membership in a joint apprenticeship training committee registered by the Division of Apprentice Standards, and a state-recognized “high-road training partnership” (as defined in Section 14005 of the Unemployment Insurance Code).   

Available credit

The amount of available credit is equal to 25% of qualified expenditures. The aggregate credit that can be claimed by each taxpayer (as determined on a combined reporting basis) is a maximum of $250,000 per year. Any unused credit can be carried over to the following eight taxable years. Availability is limited as the total cumulative amount of HRCTC available to all taxpayers is $20 million. 

To claim the HRCTC on your California tax return, you must reduce any deduction or credit otherwise allowed for any qualified expenditure by the amount of the HRCTC allowed.

How do I make a tentative credit reservation — and when?  

You must make a tentative credit reservation (TCR) with the FTB to claim the credit. This reservation must be made online and once you’ve done so, you’ll receive an immediate confirmation. FTB currently reports that the system will be up and running by July 1, 2023, but you can start preparing now.  

How we can help

The HRCTC is a valuable tax credit opportunity for any commercial cannabis business operating in California. Determining if you qualify and calculating how much you can save could be complex. Our extensive experience in cannabis, cannabis tax, and state and local tax enables us to help you take advantage of this tax credit so you can stay focused on thriving in this ever-growing, culture-shaping industry. 

Reach out to MGO’s State and Local Tax team to find out whether you qualify for this tax credit opportunity and determine how much you could potentially save. 

• President Biden has signed the Inflation Reduction Act of 2022 into law.
• This large package contains many new tax credits to incentivize taxpayers to “go green” with energy from renewable resources while simultaneously receiving financial relief.
• It also extends or adds to currently existing credits for additional tax-saving opportunities.

On August 16, President Joe Biden signed the Inflation Reduction Act (IRA) of 2022 into law. Within the large tax reform package are numerous “green” tax credits focused on providing financial relief to taxpayers while incentivizing them to make sustainable choices and combat climate change.

These new credits are aimed at motivating taxpayers to use energy from renewable sources, prioritizing options like wind and solar. The IRA also introduces new credits and strengthens or extends existing credits that provide tax relief for purchasing new and used clean-energy vehicles and installing energy efficient heating and cooling systems. Additionally, companies that cut their methane emissions can access certain credits, while those that do not could face penalties.

The rules and regulations around claiming these green credits can be complicated. In this article, our Tax Credits and Incentives team breaks down how individuals and organizations can capitalize on these tax saving opportunities.

Swap gas guzzlers for an electric vehicle

Taxpayers that purchase a new or used “clean car” can qualify for this consumer tax credit. Vehicles considered clean are those that use a battery partly or fully manufactured in North America and built with materials extracted or processed in one of the countries currently in a free-trade agreement with the U.S.

Your income is a factor in how much you can reap in tax credits. If a taxpayer makes less than $150,000 annually (or has a combined family income below $300,000), the taxpayer can get up to $7,500 for new electric vehicles that qualify. Note the money would be applied at the point of sale, so the taxpayer’s monthly payments would be lowered (as opposed to reducing the tax bill months down the line).

Previously, the federal tax credit for electric vehicles did not include cars from manufacturers that already sold at least 200,000 models (GM, Toyota, and Tesla were excluded). This bill unravels that; instead, there is now a price threshold per vehicle. To qualify for the credit, bigger vehicles like SUVs, pickup trucks, and vans would have to cost less than $80,000 to qualify for the credits. Smaller vehicles are capped at $55,000. So, if you have your eye on a super sporty electric vehicle, you may be out of luck.

Taxpayers can also get $4,000 off a used electric vehicle if it is sold by a dealer for $25,000 or less — but only if they individually make up to $75,000 annually or $150,000 jointly. The addition of credits for used electric vehicle purchases is a win for the industry, and advocates of the bill are hopeful that this incentive will encourage an increase in electric vehicle adoption.

Modifying your home to be more energy efficient

To incentivize taxpayers to make their homes more energy efficient, the bill’s $4.28 billion High-Efficiency Electric Home Rebate Program provides rebates for low- and moderate-income households when they replace fossil-fuel boilers, furnaces, water heaters, and stoves with more efficient electric devices powered by renewable energy.

Some taxpayers will need to upgrade their electrical panels before they are able to install the new appliances. They can take advantage of up to $4,000 to do so. Furthermore, if they are interested in making their home generally more energy efficient, they can capitalize on a rebate of up to $1,600 given to seal and insulate their house, as well as up to $2,500 to improve their home’s wiring.

In terms of appliances, taxpayers can get up to $8,000 to install heat pumps that both heat and cool their home, plus as much as $1,750 for a heat-pump water heater. To offset the cost of a heat-pump dryer or electric stove, taxpayers can claim up to $840. It is estimated by making these changes, they can save significantly on their future energy bills.

There are several parameters for these rebates. First, the program runs through September 30, 2031 — so you do have time to implement these changes to your home. The maximum amount taxpayers can collect is $14,000, and to qualify, their household income cannot exceed $150% of the median income in the area they live. For those who do not qualify, there is a tax credit of up to $2,000 available to install heat pumps, plus up to $1,200 annually to install new windows, doors, or an induction stove.

Save when installing solar panels

Lastly, taxpayers can collect a 30% tax credit for installing residential solar panels through December 31, 2034. The credit decreases to 26% if you wait until after December 31, 2032. Taxpayers can also install solar battery systems to qualify for the tax credit.

New “green” tax credits

There are other ways taxpayers can take advantage of going green. Here are some of the new tax credits to capitalize on.

Doubling of R&D Tax Credits for Small Business Startups — Would potentially allow recipients to double the amount they can claim on any R&D tax credits (from $250,000 to $500,000 per year against payroll taxes).

Zero Emission Nuclear Power Production Credit — Provides a new business credit for electricity produced by a taxpayer at a qualified nuclear power facility before the date of enactment.

Sustainable Aviation Fuel Credit – Creates a new business credit for each gallon of sustainable aviation fuel sold or used as part of a qualified fuel mixture. The credit equals the number of gallons of sustainable aviation fuel in the mixture multiplied by the base amount of $1.25. There are increases available if the taxpayer meets certain greenhouse gas emissions reductions, and it applies to fuel sold or used in 2023 and 2024.

Production of Clean Hydrogen Credit — Given to producers of clean hydrogen during the ten-year period beginning on the date a qualifying facility is originally placed in service. It applies to clean hydrogen produced after 2022.

Advanced Manufacturing Production Credit — Provides a new production credit for each eligible solar energy component, wind energy component, eligible inverter, qualifying battery component, and applicable critical mineral produced by a taxpayer in the U.S. (or in U.S. possession and sold to an unrelated person). It applies to components and minerals produced and sold after 2022.

Clean Electricity Production Credit — New business credit for clean electricity facilities placed in service after 2024 (where the greenhouse gas emissions rate is not greater than zero). The credit amount equals the kilowatt hours of electricity produced and sold multiplied by the base amount of 3 cents or 1.5 cents. The credit will phase out one year after the later of 2032 or the year when annual greenhouse gas emissions from U.S. production are equal to less than 25% of the 2022 emissions rate (whichever comes first).

Clean Electricity Investment Credit — New investment credit for clean electricity property investments in energy storage technology and qualified facilities placed in service after 2024 where the greenhouse gas emissions rate is not greater than zero. It phases out after the later of 2032 or when the annual greenhouse gas emissions from U.S. electricity production are equal to or less than 25% of the 2022 emission rate (whichever comes first).

Clean Fuel Production Credit — Creates a business credit for the clean fuel a taxpayer produces at a qualifying facility and sells for qualifying purposes. The fuel must meet certain emissions standards.

Extension and modification of “green” tax credits

Several tax credits already in existence were extended and modified in the Inflation Reduction Act. They include:

Renewable Electricity Production Tax Credit (PTC) — Extends the beginning of construction deadline for certain renewable electricity production facilities through the end of 2024, as well as reduces the base amount of credit with the potential to qualify for five times that amount. It applies to facilities placed in service after 2021, and increases the credit amounts for domestic content, energy communities, and hydropower.

Energy Investment Tax (ITC) — Extends the beginning of construction deadline for some types of energy property, including qualified fuel cell property, for one year through the end of 2024. It extends the beginning of construction deadline for geothermal equipment through the end of 2034 and permits the credit for new types of energy property like energy storage technology, microgrid controller property, and qualified biogas.

Carbon Oxide Sequestration Credit — Extends and enhances carbon oxide sequestration credits for qualified industrial facilities and direct air capture facilities IF construction begins before 2033. It also lowers the minimum carbon capture requirement, and generally applies to those facilities and equipment placed in service post-2022.

Tax Credits for Biodiesel, Renewable Diesel, and Alternative Fuels — Extends these tax credits through 2024 and apply to fuel sold or used after 2021.

Second Generation Biofuel Credit — Extends tax credits to second generation biofuel through 2024 and applies to second generation biofuel production after 2021.

Nonbusiness Energy Property Credit — Extends this credit through 2023, as well as changes the credit rate to 30% for both qualified energy efficiency improvements and residential energy property expenditures. It replaces the $500 lifetime limit with a $1200 annual limit, modifies the limits for specific types of property, and modifies standards for qualified energy efficiency improvements on property placed in service after 2022.

Residential Energy Efficient Property Credit — Extends the residential energy-efficient property credit through 2034 and replaces the credit for biomass fuel property expenditures with a new credit for battery storage technology expenditures on those made after 2022.

New Energy Efficient Home Credit — Extends the business credit for contractors who manufacture or construct energy efficient homes through 2032. It applies to dwellings acquired by the contractor after 2022.

Alternative Fuel Vehicle Refueling Property Credit — Extends the tax credit through 2032 and increases the credit limit to $100,000 per item of depreciable refueling property and $1,000 per item of non-depreciable refueling property.

Advanced Energy Project Credit — Extends the competitively awarded investment tax credit for clean energy and energy efficiency manufacturing projects. It provides as much as $10 billion of new credit allocations effective in early 2023.

Increase in Energy Credit for Solar and Wind Facilities — In order to qualify, one must have a maximum net output of less than five megawatts and must be in a low-income community, on American Indian land, or part of a low-income residential building project (or low-income economic benefit project), effective in early 2023.

Reinstatement of Superfund Hazardous Substance Financing Rate — Reinstates a financing rate on crude oil and imported petroleum products at a rate of 16.4 cents per gallon through 2032.

Our perspective on the Inflation Reduction Act’s tax credits

Looking ahead, it is imperative that you are ready to capitalize on these tax credits. Getting into the weeds with some of the qualifications, however, could prove challenging, and working with a professional services firm could make all the difference in ensuring you take advantage of the credits you qualify for.

At MGO, our dedicated Tax Credits and Incentives team brings more than 30 years of experience in helping you structure your expenses in a way that will help you acquire appropriate documentation, assist in calculating and claiming credits, and maximize the amount you can receive. Our full-service firm, led by experienced CPAs and attorneys, provides a holistic approach to examining your organization and determining how you can best reach your goals.

About the author

Michael Silvio is a partner at MGO. He has more than 25 years of experience in public accounting and tax and has served a variety of public and private businesses in the manufacturing, distribution, pharmaceutical, and biotechnology sectors.

While it appears that several of the more disadvantageous provisions targeting businesses won’t make it into the final bill, others may. In addition, some temporary provisions are coming to an end, requiring businesses to take action before year end to capitalize on them. As Congress continues to negotiate the final bill, here are some areas where you could act now to reduce your business’s 2021 tax bill.

Research and experimentation

Section 174 research and experimental (R&E) expenditures generally refer to research and development costs in the experimental or laboratory sense. They include costs related to activities intended to uncover information that would eliminate uncertainty about the development or improvement of a product.
Currently, businesses can deduct R&E expenditures in the year they’re incurred or paid. Alternatively, they can capitalize and amortize the costs over at least five years. Software development costs also can be immediately expensed, amortized over five years from the date of completion or amortized over three years from the date the software is placed in service.

However, under the Tax Cuts and Jobs Act (TCJA), that tax treatment is scheduled to expire after 2021. Beginning next year, you can’t deduct R&E costs in the year incurred. Instead, you must amortize such expenses incurred in the United States over five years and expenses incurred outside the country over 15 years. In addition, the TCJA requires that software development costs be treated as Sec. 174 expenses.

The BBBA may include a provision that delays the capitalization and amortization requirements to 2026, but it’s far from a sure thing. You might consider accelerating research expenses into 2021 to maximize your deductions and reduce the amount you may need to begin to capitalize starting next year.

Income and expense timing

Accelerating expenses into the current tax year and deferring income until the next year is a tried-and-true tax reduction strategy for businesses that use cash-basis accounting. These businesses might, for example, delay billing until later in December than they usually do, stock up on supplies and expedite bonus payments.

But the strategy is advised only for businesses that expect to be in the same or a lower tax bracket the following year — and you may expect greater profits in 2022, as the pandemic hopefully winds down. If that’s the case, your deductions could be worth more next year, so you’d want to delay expenses, while accelerating your collection of income. Moreover, under some proposed provisions in the BBBA, certain businesses may find themselves facing higher tax rates in 2022.

For example, the BBBA may expand the net investment income tax (NIIT) to include active business income from pass-through businesses. The owners of pass-through businesses — who report their business income on their individual income tax returns — also could be subject to a new 5% “surtax” on modified adjusted gross income (MAGI) that exceeds $10 million, with an additional 3% on income of more than $25 million.

Capital assets

The traditional approach of making capital purchases before year-end remains effective for reducing taxes in 2021, bearing in mind the timing issues discussed above. Businesses can deduct 100% of the cost of new and used (subject to certain conditions) qualified property in the year the property is placed in service.
You can take advantage of this bonus depreciation by purchasing computer systems, software, vehicles, machinery, equipment and office furniture, among other items. Bonus depreciation also is available for qualified improvement property (generally, interior improvements to nonresidential real property) placed in service this year. Special rules apply to property with a longer production period.

Of course, if you face higher tax rates going forward, depreciation deductions would be worth more in the future. The good news is that you can purchase qualifying property before year-end but wait until your tax filing deadline, including extensions, to determine the optimal approach.

You can also cut your taxes in 2021 with Sec. 179 expensing (deducting the entire cost). It’s available for several types of improvements to nonresidential real property, including roofs, HVAC, fire protection systems, alarm systems and security systems.

The maximum deduction for 2021 is $1.05 million (the maximum deduction also is limited to the amount of income from business activity). The deduction begins phasing out on a dollar-for-dollar basis when qualifying property placed in service this year exceeds $2.62 million. Again, you needn’t decide whether to take the immediate deduction until filing time.

Business meals

Not every tax-cutting tactic has to be dry and dull. One temporary tax provision gives you an incentive to enjoy a little fun.

For 2021 and 2022, businesses can generally deduct 100% (compared with the normal 50%) of qualifying business meals. In addition to meals incurred at and provided by restaurants, qualifying expenses include those for company events, such as holiday parties. As many employees and customers return to the workplace for the first time after extended pandemic-related absences, a company celebration could reap you both a tax break and a valuable chance to reconnect and re-engage.

Stay tuned

The TCJA was signed into law with little more than a week left in 2017. It’s possible the BBBA similarly could come down to the wire, so be prepared to take quick action in the waning days of 2021. Turn to us for the latest information.

We recently released an article detailing the red flags to look out when dealing with tax credits and incentives providers. If you think you could be at risk for future IRS issues, there is much you can do now to take a proactive approach and mitigate future negative impact. In the following, we break down steps you can take now to better understand and manage your exposure.

An overview of tax credits and incentives

Designed to encourage investment and development, job creation, growth, and certain business activities, tax credits and incentives provide an opportunity to reduce the amount of tax owed for performing certain activities. Credits and incentives are categorically different than tax deductions, which reduce the amount of taxable income.

These incentives often target desirable industries or activities like research and development, job creation for at-risk populations, and expanded growth in underdeveloped areas. When leveraged correctly, credits and incentives can be a powerful tool to funnel back resources into your organization to fuel activities you are already doing. Even more enticing, these credits can often apply retroactively if you determine you qualify for certain credits or incentives after the fact.

There are three basic types of tax credits: nonrefundable, refundable, and partially refundable. A few of the different types of tax credits pertaining to businesses in different classifications, industries, or activities performed include R&D tax credits, the employee retention tax credits, IRC Section 179D, and the work opportunity tax credit. To learn more about their eligibility rules, visit our previous article.

Understanding the risk of IRS tax audits

There is a three-year statute of limitations from the due date of the tax return or the filing date (whatever is later) for the IRS to assess your filings. That means if you think you may be exposed but escaped the IRS’ notice, you could still receive an audit notice for previous years’ returns. And if you do get audited, and the IRS determines you owe back taxes, you will get charged penalties and interest dating back to the infraction itself.

This is even more risky when considering the IRS’s extreme backlog. These IRS tax audits can sometimes take years to complete and if your credit and incentive calculations are the topic of interest, you’ll need to halt any future credit analysis until the situation is resolved. Meanwhile, you’ll be devoting crucial resources, time, and effort working with the IRS for something that yields no financial value and distracts from more conducive business activities.

Reasons to get a head-start and address issues now

Even though there is no guarantee you will get audited, you are still taking a risk if you do not address potential tax credit and incentive exposures in your organization. It may seem easy to “roll the dice” and hope the issue will remain uncovered, but it could come at a cost — especially if you are planning to make some big moves, like engaging in transaction of your business (M&A), going public, or embarking on another major transaction.

During the due diligence period of these transactions, it is almost certain any uncovered tax issues will emerge. You will likely not recover the value of these credits or remain on the hook for potential liability. Even worse, the exposure of these issues reflects negatively on your accounting and control system, potentially lowering the purchase value of your organization or undermining whatever deal you had in place prior to the due diligence. Often your transaction partners will start to question your organization’s trustworthiness, and reputation … due to something that may be no fault of your own.

So, you’ve been exposed … but haven’t received an IRS audit notice

Here is the deal: you know for certain you have been exposed, but you have not been notified by the IRS yet. You probably have a lot of questions — will you get an audit notice? Have you escaped unscathed? Do you need to address the issues preemptively, just in case? It may be overwhelming to decide how to proceed once you realize the exposure.

We suggest working with a qualified CPA firm to review your tax filings. A full-service accounting firm will review your organization holistically at a minimum rate, uncover any exposures, and deliver valuable peace of mind. If the firm does find issues, you have two options:

• Update your credit and incentive filings moving forward.
  • While this will likely decrease the amount you can deduct, it exemplifies transparency.
• Issue a Voluntary Disclosure (VA) if the exposure is significant and you do not have a lot of time to fix the issue.
  • Essentially, you are volunteering to correct your mistakes by recalculating the credits claimed and paying back the difference.
  • While this may sting a little, the IRS looks favorably upon organizations who are proactive to fix the issue by filing a VA and they are likely to waive any penalties or interest you would have had to pay.

You’ve received an IRS audit notice. Now what?

Well, it happened. You received an audit note from the IRS. Before you panic, here is what you need to do:

• Start preparing your documentation right away. The sooner you have your ducks in a row, the sooner you are prepared to handle the audit.
• Check the contract you signed with your original provider and verify if they provide controversy support services for situations like these.
  • If they do, reexamine the quality of their work. Do they have any of the red flags mentioned in this article? Could something they have done have caused the audit?
  • Consider engaging a qualified CPA firm as your new provider to handle the subsequent controversy support. Someone you trust can get you ready for any available credits and incentives moving forward, too.
• If you used a provider that displays any red flags, you could have some leverage for a reasonable cause defense. Because the “professional” firm handled it for you and made a mistake, you could utilize a first-time penalty abatement, which means you can get relief from a penalty if you:
  • Did not previously have to file a return or if you do not have any penalties for the three years before the tax year you received a penalty;
  • Filed all currently required returns or an extension of time to file;
    and
  • Paid or have arranged to pay any tax due.
• Verify your contract with the original provider to determine if you have any recourse to seek compensation from them. If the IRS does issue any penalties, you will want to ensure you do not have to pay.

Standalone firms vs. full-service accounting firms

Let’s say you haven’t received an IRS notice, and you do not think you are in danger of receiving one. How can you ensure you will not in the future? It comes down to choosing a firm to help you maximize the potential of these tax credits and incentives.

The bottom line: it is imperative you work with a certified public accounting (CPA) firm instead of a standalone firm. Because standalone firms often use lower-cost, less-experienced recent graduates who are not certified public accountants, there is a distinct lack of knowledge and background in the accounting fundamentals, causing you to be misled by those unequipped to help with complex tax matters. You also run the risk of being oversold benefits by aggressive firms that not only exaggerate the amount you are receiving from the tax credits and incentives, but also behave in a way that attracts IRS attention and jeopardizes your firm.

A full-service accounting firm, on the other hand, knows how to look at an organization holistically — and it has many more capabilities and professionals with experience. It looks at things through various lenses and can advise how certain positions will impact current and future tax positions. Full-service firms also likely have an in-house controversy team that has handled hundreds of audits successfully—so you will be in good hands.

Our perspective

Tax credits and incentives provide plenty of benefits you do not want to miss out on, and their often-complex application and qualification processes are reason enough to hire a professional accountant to help you maximize your returns. Unfortunately, we often see organizations placing their trust in the wrong providers and they end up suffering the consequences of an IRS audit. For many, it is simply easier and safer to cut off the relationship with the initial provider and start fresh with a professional firm you know you can trust.

At MGO, our dedicated Tax Credits and Incentives team brings more than 30 years of experience fixing these types of issues and working with the IRS to limit the damage. We provide cleanup in the event you are being audited by the IRS (or could be audited in the future), and help you identify areas where you can claim tax credits and incentives for next time. If you are concerned, our best advice is to get ahead of it with an opinion you can trust — before the IRS decides to investigate themselves.

About the author

Michael Silvio is a partner at MGO. He has more than 25 years of experience in public accounting and tax and has served a variety of public and private businesses in the manufacturing, distribution, pharmaceutical, and biotechnology sectors.

In recent years, a number of firms have emerged specializing in credits and incentives and building large businesses by over-promising and under-delivering these tax consulting services. While credits and incentives are enticing, they must be handled with extreme care, as the consequences of getting it wrong can be serious.

At MGO, we not only help you determine if you are eligible for these valuable tax credits and incentives, but we also perform damage control and clean-up following bad actors’ broken promises and sloppy work. We have seen firsthand the fallout from their poor performance and how it affects clients. In this article, we will help you understand what to look for in a tax credits and incentives provider and recognize and avoid IRS red flags so you can safely capitalize on these opportunities.

An overview of tax credits and incentives

Designed to encourage investment and development, job creation, growth, and certain business activities, tax credits and incentives provide an opportunity to reduce the amount of tax owed for performing certain activities. Credits and incentives are categorically different than tax deductions, which reduce the amount of taxable income.

These incentives often target desirable industries or activities like research and development, job creation for at-risk populations, and expanded growth in underdeveloped areas. When leveraged correctly, credits and incentives can be a powerful tool to funnel back resources into your organization to fuel activities you are already doing. Even more enticing, these credits can often apply retroactively if you determine you qualify for certain credits or incentives after the fact.

There are three basic types of tax credits: nonrefundable, refundable, and partially refundable. Here, we break down just a few of the different types of tax credits pertaining to businesses in different classifications, industries, or activities performed:

R&D Tax Credits

Designed to incentivize innovation, this dollar-for-dollar tax savings has both Federal and State-level implications and can save you up to 15% on qualifying activities. To claim an R&D tax credit, your company must pass a four-part test and be involved in the technical development of new or improved products or processes. This can apply to product enhancements, product development, software development, process improvements, and more.

Employee Retention Tax Credit

The ERTC was created to provide much-needed financial relief for businesses affected by the COVID-19 pandemic. With complex eligibility requirements, the refundable tax credit awards qualifying employers with a payroll tax credit of up to $26,000 per employee as an incentive to retain them on payroll through potential closures, quarantines, and other hardships. Since its rollout, the ERTC has been expanded to continue providing relief to an even larger group of employers, even retroactively (albeit with a smaller maximum amount per employee for 2021).

IRC Section 179D

This popular tax incentive gives designers, builders, and building owners the opportunity to obtain a tax deduction of up to $1.80 per square foot if they install eligible energy efficient buildings and systems that reduce the power and energy costs by 50% or more compared to the minimum standard requirements. Tenants are eligible if they make the construction changes, and the deduction can be claimed on both retrofits and new construction projects. Buildings that qualify include commercial buildings like parking garages and warehouses, government-owned buildings like universities and libraries, and apartment buildings with four stories or more.

Work Opportunity Tax Credit

A federal tax credit for employers looking to invest in American job seekers who face barriers to acquiring employment, the WOTC is claimable if the employer 1) meets their business needs, and 2) does so by hiring an employee from a WOTC targeted group (which include veterans, ex-felons, and qualified long-term unemployment recipients, among others). An employer interested in claiming this credit must verify the new hire is a member by applying and receiving a certification.

Risks associated with claiming tax credits and incentives

While there are many benefits to tax credits and incentives, there are a few risks attached to claiming them on your tax return.

One risk is exposing your organization to an IRS audit. An audit does not always mean trouble — at least, not if you are doing everything right — but having to go through the process of complying means you are devoting time and effort to something that yields no financial value, ultimately draining resources from more conducive business activities. Working with IRS representatives and organizing and submitting documentation is labor-intensive.

A significant issue to note is that if you overstate your credits, the IRS’s software may flag the subsequent higher score for the return, sparking an audit — so claim succinctly and accurately. Then, of course, there is the issue of an audit exposing issues unrelated to your tax credits, making you vulnerable to even bigger problems.

Another risk is payback. Tax credits do not have payback requirements, but some tax incentives do, and along with them come penalties for failing to pay in a timely manner. You may also then accrue interest, which can add up quickly. This negates the incentives in the first place, only causing a bigger headache.

Red flags to look for in tax credit and incentive providers

To maximize the potential of the credits, working with a certified public accounting (CPA) firm is absolutely essential. Non-CPA firms do not have to adhere to strict accounting guidelines. Additionally, they may not have the requisite experience or perspective to assess your situation holistically. A trained and licensed professional will examine your operations, uncover missed opportunities, and help you capitalize on a lower tax liability. But choosing unwisely can have major ramifications and increase your chances of being audited by the IRS.

Here are some of the most important red flags to look for when selecting a provider:

1. Standalone tax credits and incentives firm

Firms that do not utilize CPAs often use lower-cost, less-experienced recent graduates who act more in a sales-focused capacity than as an accountant. This lack of knowledge and background in accounting fundamentals can result in you being misled by someone who is not equipped to help with complex tax matters.

2. They only take contingency-based payments

Stay away from firms that take 25-35% of the savings recouped in fees. This is a sales approach that is commission-based by maximizing your credit, and you can assume they are being incentivized by these fees to over-promise — which means they will almost certainly underdeliver. Another negative? If an auditor sees your tax provider takes contingency-based payments, they will automatically assume they are acting in bad faith and then comb through your past credits to verify their accuracy. And they can look through your last three tax returns, making you even more vulnerable.

3. They market a team of “experts” with IRS or legislative backgrounds

Look out for firms that tout their employees as experts who have specialized backgrounds tailored to helping you get your tax credits. Whether or not they actually have IRS or legislative backgrounds, at the end of the day, a firm’s work should speak for itself. There is no need for flashy marketing collateral that boasts expertise without proof.

4. They bundle tax work with controversy and audit support

A combo deal is great when it is a burger, fries, and a Coke, but when it comes to your tax work, you should be looking for individualized support. Firms that package tax work with controversy and audit support are trying to catch your eye, saying, “Look at everything we can offer you!” If the tax assessment they provide is strong, these packages are not necessary and you’re paying for something you shouldn’t need in the first place.

5. There is a history (often public) of a toxic work culture

Do not be afraid to Google the firm you are considering. If several articles pop up detailing sordid work environments that include sexual harassment; lawsuits against former clients and employees; and obviously fake Glassdoor reviews, you can assume the firm itself is a red flag.

6. Targeting of less-sophisticated businesses as clients

Be aware of firms that go after mid-market and below businesses that are less “sophisticated” than other potential clients. They will usually peddle less-than-legitimate sales tactics, like promising a Porsche or other luxury vehicle, as an incentive to lure these businesses into hiring them. Red flag firms know less refined companies will not catch on to these “scummy” offers because they do not have the experience to know any better.

7. They employ a “cut-and-paste” approach

Many tax credits, like the R&D tax credit, require year-by-year claims, and in order to qualify, your tax return must depict work calculated and substantiated independent of years past. If a firm utilizes the “cut-and-paste” approach from the year before, this indicates sloppy work — and a red flag indicating you should choose a tax provider willing to perform the work necessary year after year without cutting corners and risking an IRS audit.

Keys to selecting a reliable tax credits and incentives provider

Now that you know what to avoid, here are some things a tax provider should have in order to best assist you with tax credits:

1. They are a full-service accounting firm.

A full-service accounting firm knows how to look at an organization holistically, providing the services necessary simply by peering beneath the hood. They will know how things work, and we are happy to tell you how to optimize — including how tax credits can be used or monetized within your business. Look for a firm that provides tax, audit, controversy, and more services, all under one roof.

2. They prioritize the security of your information.

A good tax provider knows your information is sacred and will treat it as such. While cybersecurity risks are never fully eliminated, stick with a firm with SOC or equivalent data protection. This way you are much less likely to have your sensitive financial information exposed in the event of a data breach.

3. They employ quality control

Look for a firm that utilizes multiple levels of internal review, so you know that the work you are getting has been vetted and approved by a strong system of quality control — all with your best interests in mind. When you are dealing with something like tax credits, you cannot take the easy way out or cut corners, so finding a provider that maintains control strength is crucial.

4. They never make a decision for you

While you want to trust your tax provider, at the end of the day, whatever decisions your organization makes regarding your tax credits affects you and only you. A reliable firm will not pressure you into questionable decisions. They will empower you through thorough education so you can feel confident making the right choice yourself.

5. They charge you a fixed rate based on hours worked

Unlike a red-flag firm, the firm you want to hire only charges a fixed rate based on the hours they work for you, rather than contingency-based charges taken from the recoup. This indicates they are focused on the outcome for you, not what that return means for them. A firm like MGO will perform an initial fact-find to determine eligibility and then make a conservative estimate, so you know exactly what to expect.

6. They follow a professional approach

Professional means qualified, and a good firm provides services from specialists with real certifications and strong backgrounds in the industry. Look for a tax provider that regularly publishes news, articles, and thought leadership detailing emerging opportunities and risks. The team you hire is embarking on a journey with you — and to create opportunities, gain competitive advantages, and see your hard work culminate in rewards, you want to work with someone you can trust: someone proactive and well-informed.

Our perspective on ethics in tax credits and incentives

Tax credits and incentives provide plenty of benefits you do not want to miss out on — and their often-complex application and qualification processes are reason enough to hire a tax provider to help you maximize your returns. However, it is important to be aware that not just any tax provider will do. Be aware of red flags and know what specifically to look for in a firm.

At MGO, our dedicated Tax Credits and Incentives team brings over 30 years of experience. We will take a holistic view of your operations and processes to identify areas where you may be able to claim tax credits and incentives.

About the author

Michael Silvio is a partner at MGO. He has more than 25 years of experience in public accounting and tax and has served a variety of public and private businesses in the manufacturing, distribution, pharmaceutical, and biotechnology sectors.

Understanding the CTC, then and now

The CTC was established in 1997. Unlike a deduction, which reduces taxable income, a credit reduces the amount of taxes you owe on a dollar-for-dollar basis. While some credits are limited by the amount of your tax liability, others, like the CTC, are refundable, which means that even taxpayers with no federal tax liability can benefit. Historically, the CTC has been only partially refundable in that the refundable amount was limited to $1,400.

The American Rescue Plan Act (ARPA) significantly expands the credit, albeit only for 2021. Specifically, the ARPA boosts the CTC from $2,000 to $3,000 per child ages six through 17, with credits of $3,600 for each child under age six. Plus, the CTC is now fully refundable. It also affords taxpayers the opportunity to take advantage of half of the benefit in 2021, rather than waiting until tax time in 2022.

Note, however, that there are limits to eligibility. The $2,000 credit is subject to a phaseout when income exceeds $400,000 for joint filers and $200,000 for other filers, and this continues under the ARPA — for the first $2,000. A separate phaseout applies for the increased amount: $75,000 for single filers, $112,500 for heads of household and $150,000 for joint filers.

Receiving advance payments

The ARPA directed the U.S. Treasury Department to begin making monthly payments of half of the credit in July 2021, with the remaining half to be claimed in 2022 on 2021 tax returns. For example, a household that’s eligible for a $3,600 CTC will receive $1,800 ($300 in six monthly payments) in 2021 and would claim the balance of $1,800 on the 2021 return. The payments will be made on the 15th of each month through December 2021, except for August, when they’ll be paid on August 13.

To qualify for advance payments, you (and your spouse, if filing jointly) must have:

• Filed a 2019 or 2020 tax return that claims the CTC or provided the IRS with information in 2020 to claim a stimulus payment,
• A main home in the United States for more than half of the year or file a joint return with a spouse who has a U.S. home for more than half of the year,
• A qualifying child who’s under age 18 at the end of 2021 and who has a valid Social Security number, and
• Earned less than the applicable income limit.

If the IRS has your bank information, you’ll receive the payments as direct deposits.

Because the IRS will base the payments on your 2020 tax return (or, if not yet available, your 2019 return), it’s possible that you could receive excess payments over the amount you actually qualify for in 2021. In that case — unlike excess stimulus payments — you’ll be required to repay the excess. The IRS will either deduct the amount from your 2021 refund or add it to the amount you owe.

Opting out

The IRS will automatically enroll taxpayers for advance payments, but it’s also providing an online portal at irs.gov where taxpayers can opt out. You might consider opting out if, for example, you were near the income limits in 2019 or 2020, expect to earn more in 2021, and want to avoid excess payments. Be aware that couples filing jointly must both opt out, otherwise the spouse who doesn’t will receive half of the joint payment.

It’s not only a change in expected income that could lead to excess payments; it’s also a change in the number of dependents. For example, divorced couples who share joint custody may alternate the years in which they claim their children as dependents for CTC purposes. If 2021 is your former spouse’s year, consider opting out (your former spouse won’t receive the advance payments based on his or her 2020 tax return but, if eligible, can claim the credit on the 2021 return). Parents of children who will turn age 18 in 2021 also should consider opting out.
The deadline to opt out of the first payment was June 28, 2021, but you can still opt out for future payments.

Estimating, and reducing, 2021 income

When deciding whether to opt out, you can estimate your 2021 income using multiple methods. You could simply look at your modified adjusted gross income on your most recent tax return. You also could project your income for the year and reduce it by the standard deduction (for 2021, it’s $12,550 for individual taxpayers and $25,100 for married couples filing jointly).

If you estimate that your income will be near the eligibility threshold but want to receive the advance payments, you can take measures to reduce your income before year end. You might, for example, increase your 401(k) plan contributions (the contribution limit for 2021 is $19,500). Taxpayers with high deductible health plans and health savings accounts (HSAs) can similarly reduce their income with contributions. The HSA contribution limits for 2021 are $3,600 for individual health plans and $7,200 for family health plans.

Beyond 2021

The expanded CTC is available only for 2021 as of now. President Biden has indicated that he’d like to extend it through at least 2025, and some Democratic lawmakers hope to make it permanent. But it’ll be challenging to pass a bill to make either of these proposals happen. We’ll keep you informed about any developments that could affect your tax planning.

Tax incentives for telemedicine tools

Health care professionals are incorporating tablets, chat capabilities, and other mobile solutions to diagnose more patients in a shorter amount of time and across geographical boundaries. This demand for innovation presents opportunities for software companies, and the development of these technologies is being encouraged by Federal and state Research and Development (R&D) Tax Credits.

About the R&D tax credit

Enacted in 1981, the Federal R&D Tax Credit allows a credit of up to 14 percent of eligible spending for new and improved software products.

To qualify as an R&D activity, one must meet each of the following criteria:

• Technological in nature. Activities must be based on hard science.
• Qualified purpose. Activities must be intended to develop a new or improved product or process.
• Technological uncertainty. Activities must be aimed at eliminating uncertainty with respect to the development of a product or process.
• Process of experimentation. Activities must involve a systemic or iterative approach of evaluating different alternatives to eliminate ambiguity.

Eligible costs include:
• Employee wages
• Supplies
• Contract research expenses

Software companies developing platforms to enable and improve remote health care may be able to take advantage of the R&D Tax Credit as a dollar-for-dollar tax saving for the work that they are already doing.

Software activities that may qualify for a tax credit
If your company is investing in developing telemedicine platforms, you may be able a claim an R&D Tax Credit. Though each situation is unique, development activities for the following products may qualify:

• Tools that allow physicians to view medical images and other data on mobile devices such as smartphones, tablets, and other electronic devices
• Application programming interfaces and capabilities to transfer information electronically and view electronic medical files
• Cloud-based platforms to enable health care providers to directly engage patients in an easy-to-use virtual care environment that is HIPAA compliant
• Platforms with the capabilities of linking physicians and pharmacies to allow physicians to submit a prescription electronically
• Wearable devices with sensors to provide continuous monitoring of patients and automated treatment for health conditions
• Virtual therapy platforms for online counseling
• Medical data cloud storage solutions and data security

How we can help

The pandemic put our current telemedicine capabilities to the test, and patients gave these innovations a passing grade. But we have yet to experience the true power of telemedicine. As the innovation continues and popularity grows, we can be certain of even more widespread acceptance of telemedicine. And as the need continues to increase, it appears that the various tax credits for research and development will be available to help support the work of those who develop technology in the health care sector.

MGO professionals bring over 25 years of R&D Tax Credit experience to help you identify, analyze, file, and defend your claim. We provide a no-cost eligibility analysis to determine if these tax incentives are appropriate to your situation.

About the author

Michael Silvio is a partner at MGO. He has more than 25 years of experience in public accounting and tax and has served a variety of public and private businesses in the manufacturing, distribution, pharmaceutical, and biotechnology sectors.

Home office deduction for the self-employed

If you are an independent contractor, a sole proprietor, or self-employed, and you use a portion of your home exclusively and regularly for business, you could be entitled to home office deductions. There are several expenses that potentially fall under this umbrella, including electricity, water, gas, trash collection, maintenance, depreciation, repair, internet, insurance, rent, real estate taxes, mortgage interest, and the costs of installing and maintaining home security systems.

Beyond utilities, if you have made improvements to your home to accommodate your work situation, you may be able to deduct these expenses as well. Purchases like furniture, computers and accessories, and general office supplies may qualify.

Listed properties, or items used for both business and personal, must be utilized more than 50% annually for depreciation to be claimed on the business-use portion or be deducted as an applicable expense. These include your phone system, some furniture and computers, and peripheral equipment like wireless routers, desktop cameras, and printers. If the listed property is not used more than 50% for business, then you can only use the slower “straight line” depreciation method, and you cannot deduct it under the expensing provisions. However, if they were placed in service after 2017, they may be eligible for regular depreciation, or they can be deducted in full without having to meet the 50% business use test.

If you want to claim your deductions, you have to use part of your home for one of the following:

• Regularly and exclusively as a primary place of business for a trade or a business.
• Regularly and exclusively as a place where you meet with clients, patients, or customers in the normal course of a trade or business.
• As a separate structure not attached to the home, used regularly and exclusively in connection with a trade or business.
• Regularly for storage, inventory, or product samples that are used in a trade or business of selling products at retail or wholesale.
• For rental use.
• As a daycare facility.

Once the “regularly” and “exclusively” tests have been satisfied, the home office deduction is calculated by dividing the area of the office portion over the total area of the house to calculate the percentage of expenses that can be claimed, and then prorating for use over the year. This can be complicated in certain circumstances so it is highly recommended you coordinate with your tax advisor before claiming this deduction.

Home office deductions for partnerships

If you are a partner of a partnership and use a portion of your home regularly and exclusively for partnership business, you can deduct the home office expenses as long as the expenses will be paid without reimbursement under the partnership agreement or the firm policy. If the expenses include losses from a passive activity, be sure to enter them as well. It requires several forms to properly calculate acceptable reimbursable expenses.

As the shareholder of a corporation

If you use a part of your home regularly and exclusively for a corporation’s business as a shareholder of a corporation (either a regular “C” or subchapter “S” corporation), you are essentially an employee of the corporation, and unfortunately, no home office expense deductions can be implemented.

Home office deductions for W-2 employees

Prior to the Tax Cuts and Jobs Act (TCJA), a W-2 employee was able to claim itemized deductions for unreimbursed employee business expenses, including those home office expenses, as miscellaneous itemized deductions. The TCJA temporarily eliminated most miscellaneous itemized deductions at the federal level.

Through 2018-2025, you can’t deduct home office expenses at a federal level as an employee. But don’t despair. They may be currently deductible as itemized deductions in some states, including New York. Therefore, under current law, your home office expenses aren’t deductible on your Federal tax return. After 2025, however, those expenses may be claimed as miscellaneous itemized deductions at both the federal and state levels—but will be subject to rigorous rules.

Final thoughts

The Home Office Deduction can be a powerful way to limit your federal tax burden. However, historically, the Home Office Deduction has earned a reputation as an IRS audit trigger. The likely major increase in claimants for 2020 taxes, and the fact that most employees will not be able to take the deduction, means those that do claim it could be at high risk for IRS scrutiny. We recommend that you consult with dedicated tax professionals before claiming the Home Office deduction on your 2020 tax returns.

Last year’s Tax Cuts and Jobs Act, H.R. 1 (“the Act”) created a federal capital gains tax deferral program through the opportunity zone statute, which is designed to attract private, long-term investments in low-income and economically distressed communities. Over 8,700 communities designated as Qualified Opportunity Zones (QOZ), located across all 50 states, territories and Washington D.C, were nominated by local governments and confirmed by the Department of Treasury (DoT) in Notice 2018-48 issued in June 2018.

The statutory language of the Act introduced the tax incentive deferring taxable gains but it did not provide important details, including the types of gains eligible for deferral, the timing and specific requirements  of qualified investments, and how investors report deferred gains. On October 19, 2018, the Treasury Department released proposed regulations, a revenue ruling, and tax forms to provide additional guidance on the opportunity zone tax incentive.

How QOZ tax incentives work

Simply stated, the opportunity zone statute allows for the deferral of capital gains if some or all of the amount of the capital gain recognized is invested in a Qualified Opportunity Fund (QOF) by an eligible taxpayer. A QOF is any entity that invests in qualified opportunity zone property and is taxed as a partnership or corporation organized in any of the 50 states, US territories, or D.C. The QOF is required to hold at least 90 percent of its assets in qualified opportunity zone property.

To defer a capital gain, a taxpayer has 180 days from the date of sale or exchange of the appreciated property to invest the recognized gain in a QOF. The potential tax benefits of opportunity zone statute include:

• Deferral of tax on capital gains invested in a QOF through 2019: Any recognized capital gain invested in a QOF through December 31, 2019 may be deferred until December 31, 2026 or eliminated when an investment in a QOF is disposed. There is an opportunity for taxpayers to make multiple investments in QOFs through the statute expiration date.
• Potential to eliminate 15% to 100% of taxes for capital gains invested: Capital gains invested in a QOF are deemed to have an initial tax basis of zero. The taxpayer receives a 10% increase in tax basis if the investment is held five years and an additional 5% increase in tax basis after seven years. If an investment in a QOF is held for ten years, the taxpayer can elect to increase their tax basis in the QOF to fair market value upon disposition, which provides for a tax-free investment in the QOF. Tax is realized on the excess of the deferred gain over the basis in the QOF at the time of disposal.
• Ability to rollover gains on disposal of investments in QOF: In general, the original deferred gain must be recognized by the taxpayer upon disposition of the investment in the QOF. If a taxpayer disposes of all of an investment in a QOF, triggering tax on the deferred gain and the qualified opportunity zone property, a taxpayer can make an investment in a new QOF and rollover the deferred gain. The rollover investment must be made before December 31, 2026.

Qualified Opportunity Zone Property

The purpose of the opportunity zone statute is to incentivize investment in low-income areas of the country in need of community development and improvement. IRC Sec. 1400Z-2(d)(2) provides guidance regarding the types of assets that will be considered qualified opportunity zone property if held by a QOF. In general, qualified opportunity zone property includes the following:

• Newly issued stock held in a domestic corporation if such corporation is a qualified opportunity zone business,
• Newly issued partnership interests in a domestic partnership if such partnership is a qualified opportunity zone business, or
• Qualified opportunity zone business property.

Qualified opportunity zone business property is further defined in IRC Sec. 1400Z-2(d)(2)(D) as tangible property used in a business in a qualified opportunity zone that is either:

• Land in a qualified opportunity zone,
• A building in a qualified opportunity zone that is first used by the QOF or the qualified opportunity business,
• A building in a qualified opportunity zone that was previously used but is “substantially improved” by the QOF or qualified opportunity business,
• Equipment that was never previously used in a qualified opportunity zone, or
• Equipment that was previously used in a qualified opportunity zone but it “substantially improved” by the QOF or the qualified opportunity business.

The opportunity zone statute defines “substantial improvement,” as an amount of investment in existing tangible property by a QOF, during any 30-month period, that exceeds the adjusted basis in the property at the beginning of the 30-month period. The Revenue Ruling issued clarifies that improvements made to land are not included in the total improvements for purposes of the “substantial improvement test” and the value of land is excluded from the adjusted basis calculations.

More details on qualifying as a QOF

The new guidance also provides details on what qualifies an investment vehicle as a QOF. And a draft of Form 8996, Qualified Opportunity Fund was released alongside the guidance to demonstrate how corporations and partnerships can self-identify as a QOF by including the form with the filing of their tax return. Additional information provided includes guidelines for determining when a QOF begins, how a QOF can meet the requirements to be recognized as a qualified opportunity zone business, and what pre-existing entities may qualify as a QOF. And finally, guidance details the test required of QOFs to determine whether the entity holds the minimum threshold of assets in qualified opportunity zone property.

Considering a QOZ investment?

While the new guidance helps fill in many details, many questions are left unanswered and the Department of Treasury plans to release further guidance before the end of the year. If you’re planning on creating or investing in a QOF, we recommend consulting with an experienced tax advisor first.

The tax team at MGO is ready to assist you in navigating QOZs, QOFs, and other income tax concerns. For further guidance or to schedule a consultation, please contact us.