SourceCorp: Cost Segregation Studies, R&D Tax Credits, LIFO Accounting Since 1983.

Don’t Delay
Take time now, before year-end, to review your client’s 2008 tax situation and consider tax-saving strategies that you still have time to implement. Don’t wait until it’s too late to reduce your client’s 2008 tax bill.

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1. Inventory

2. Bonus Depreciation

3. Cost Segregation Studies

4. Research and Development Credit (R&D Tax Credit)

5. Commercial Buildings Deduction

1. Inventory
CPAs should review inventory valuation methods to determine if their clients would benefit from changing accounting methods to optimize year-end deductions.

LIFO Inventory Method
Those who would benefit: Companies required to maintain inventories
Timing: Complete before the current-year financial statements are issued

There are two predominant methods used to value inventory: last in, first out (LIFO) and first in, first out (FIFO).

LIFO assumes that the first inventory sold is the newest inventory. In this case, the increased current-year prices would match with current-year revenue to result in a greater cost-of-goods-sold deduction. With inflation on the rise in many industries, adopting the LIFO method could result in a significant reduction of gross margins, thus lowering taxes and dramatically increasing cash flows this year.

Many companies have avoided electing LIFO in the past because of the difficult recordkeeping requirements for this method. With SourceCorp’s advances in accounting software and technology, however, electing LIFO has never been easier. An alternative is using the inventory price index computation (IPIC) method, which uses published indexes to compute a company’s inflation rate, which is then factored into the year-end LIFO deduction. Using the IPIC method can simplify a company’s LIFO computation and, in some cases, yield a better benefit than a company’s internal computation does.

These developments can result in significant tax benefits with relatively low implementation costs.

Companies in industries that experience rapid cost increases such as steel and oil have steady annual price increases, or deal in scarce commodities should consider adopting the LIFO inventory method to help reduce their current tax liability. Given the current trends in inflation, electing the LIFO method might mitigate some of the negative impact of increasing prices.

To determine if your clients could benefit from adopting the LIFO method of accounting, review their internal inflation rates (or request a free analysis from SourceCorp). Those currently using the LIFO method should evaluate the benefits of changing to the IPIC method.

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2. Bonus Depreciation
Those who would benefit: All companies acquiring fixed assets during 2008
Timing: Assets must generally be purchased and placed in service by Dec. 31, 2008

The Economic Stimulus Act of 2008 (ESA), signed into law Feb. 13, 2008, permits taxpayers to claim a bonus first-year depreciation deduction on qualified depreciable property. The additional depreciation deduction is equal to 50 percent of the adjusted basis of the eligible property. There is no limit on the amount of the deduction.

Assuming the IRS issues no further regulations, rules governing the new deduction are similar to rules enacted for pre-2008 bonus depreciation. Property eligible for the deduction must meet six criteria:

1. The property must fall into one of the following groups: 1) tangible property with a tax recovery period of less than 20 years; 2) purchased computer software; 3) water utility property; or 4) qualified leasehold improvement property.

2. The property must be purchased and placed in service after Dec. 31, 2007, and before Jan. 1, 2009. An exception, however, is that certain property with a production period exceeding one year and a cost in excess of $1 million might qualify for the deduction if placed in service before Jan. 1, 2010.

3. Property purchased during 2008 for which a binding agreement was in place prior to Jan. 1, 2008, does not qualify for the deduction.

4. Only property for which the taxpayer is the original purchaser qualifies for the deduction (in other words, used property does not qualify for the deduction).

5. Property purchased from a related party or self-constructed property for which construction began prior to Jan. 1, 2008, does not qualify for the deduction.

6. The property cannot be ineligible property, such as property owned by a controlled foreign corporation.

The deduction will be computed after the application of any allowable small business expensing. The deduction is not affected by short taxable years, and the deduction will be allowed for alternative minimum tax (AMT) purposes. At the time of this publication, many states had not yet indicated whether they would allow the federal bonus depreciation provisions. However, based on prior bonus depreciation legislation, it can be assumed that a majority of states will not conform to the bonus depreciation provisions for state tax purposes.

In addition, the Energy Improvement and Extension Act of 2008 (EIEA) – part of the financial rescue package signed into law Oct. 3, 2008 – allows taxpayers to claim a 50 percent bonus depreciation on qualified reuse and recycling of property. Such property includes machinery and equipment (not including buildings and real estate) used exclusively to collect, distribute, or recycle qualified reuse and recyclable materials. The property must have a useful life of at least five years, must be purchased and placed into service after Aug. 31, 2008. Only one set of bonus depreciation rules can be applied to the property. Unlike the bonus depreciation rules enacted by the ESA, this provision does not expire.

As a result, if you are thinking about placing an asset into service during 2009, it might be beneficial to accelerate your plan into 2008.

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3. Cost Segregation Studies
Those who would benefit: Companies making a significant capital investment
Timing: Complete before the current tax return due date

One of the most important long-term decisions a company can face is whether to make a major capital investment in new or existing facilities. A cost segregation study can lower the current cost of a major capital investment by maximizing the tax benefits through accelerated depreciation.

A cost segregation study involves analyzing the costs of a major capital investment and properly classifying these costs for federal tax purposes. These projects most often involve analyzing costs incurred during building construction. Commercial buildings generally have a depreciable life of 39 years. Many such costs are eligible for much more accelerated tax depreciation than is the cost of basic building structural components.

Without cost segregation, these costs can go unidentified and be depreciated as a part of the building over 39 years. Properly identifying and depreciating the eligible costs defers tax liabilities, thereby offering a cash-flow benefit and helping increase the return on the capital investment. For any buildings placed in service in 2008, the bonus depreciation provisions identified in the previous section enhance this benefit.

The benefits of cost segregation can be maximized if applied during the design phase of a project. If your company is anticipating a major capital project in the next 12 months, contact SourceCorp to discuss the opportunity to apply cost segregation.

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4. Research and Development Credit (R&D Tax Credit)
Those who would benefit: Companies that incur technological product development expenses
Timing: Complete before the current tax return due date

Over the past several years, the IRS has issued a series of proposed and final regulations dealing with the research credit. The rules for determining research that qualifies for the credit have been changed, resulting in more businesses being able to claim the credit. The Tax Extenders and Alternative Minimum Tax Relief Act of 2008 (TEAMTRA), part of the financial rescue bill signed into law on Oct. 3, 2008, extends the research credit retroactively for research expenses incurred through Dec. 31, 2009, and changes the rules for calculating the credit. These rules can be complicated and require significant documentation to justify and support credit claims.

Different methods exist for computing the regular research tax credit, depending on when a company or line of business was started. Opportunities to claim the credit abound for both older and startup companies.

An alternative incremental research credit (AIRC) is available and can be more beneficial than the regular research credit. Previous rules for revoking an AIRC election were generally burdensome and costly and kept most taxpayers from using it. As a result of the TEAMTRA, however, the AIRC will no longer be permissible for taxable years beginning after Dec. 31, 2008.

Legislation passed in late 2006 also introduced the alternative simplified credit (ASC). The ASC calculation method must be elected by the taxpayer and is applicable to all succeeding tax years unless revoked. The ASC allows for a credit equal to 12 percent of the current qualified research expense to the extent it exceeds 50 percent of the average qualified research expenses for the three preceding tax years. A reduced credit is available to taxpayers that have not incurred qualifying research expenditures in the past three years. This new method might present a significant opportunity for companies that have not qualified before for the credit because of the gross receipts limitation. Treasury regulations released in 2008 clarify some of the rules surrounding the election of the ASC. The ASC can be elected only on a return filed on time, not on an amended return, and, once elected, the method cannot be changed for that tax year. In subsequent years, however, the taxpayer may change to the AIRC or the regular method of calculation without obtaining a letter ruling. Also, for taxable years ending after Jan. 1, 2009, the TEAMTRA increases the credit rate for the ASC from 12 percent to 14 percent.

All taxpayers should re-evaluate their position on research credits based on the changes to the research and development credit. During 2008, there are three calculation methodologies to consider when claiming a credit, and a careful analysis of the options must be made. Taxpayers whose ability to benefit from the research credit was limited by high fixed-base percentages or a lack of records from the base period should consider the ASC. Taxpayers should also evaluate whether the increased percentages of the AIRC are beneficial to them.

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5. Commercial Buildings Deduction
Those who would benefit: Businesses making energy conservation improvements to their buildings or constructing new energy-efficient buildings
Timing: Energy improvement must be installed by Dec. 31, 2013

Businesses are eligible for an immediate deduction of expenses attributable to qualified energy-saving improvements to commercial buildings. To qualify for this deduction, the property must be:

• Depreciable or amortizable;
• Installed and located in the United States;
• Installed between Dec. 31, 2005, and Jan. 1, 2014;
• Installed as a part of interior lighting systems, heating, cooling, ventilation, and hot-water systems or the building envelope; and
• Designed to reduce total energy and power costs by 50 percent.

The maximum deduction is limited to $1.80 per square foot of the building on a lifetime basis; a partial deduction might be allowed, however, if a separate building system meets the requirements but the overall building does not. The partial deduction, equal to 60 cents per square foot, can be taken for comparable reductions from any one of three building systems – the building envelope, lighting, or heating and cooling system – that meets goals consistent with achieving the 50 percent savings for the entire building.

For lighting systems, unless and until the IRS issues a different final rule, the law specifies that a deduction of 30 cents per square foot can be taken if the system employs dual switching (ability to switch roughly half the lights off and still have fairly uniform light distribution) and reduces installed lighting power by at least 25 percent from values denoted in specific cited tables in the American Society of Heating, Refrigerating, and Air-Conditioning Engineers’ Standard 90.1-2001.

As lighting power reductions climb from 25 percent to 40 percent, the deduction is increased proportionally, up to 60 cents for a 40 percent power reduction (plus the dual switching allowance). This prorated deduction does not apply to warehouse lighting.

If a deduction is allowed for energy efficient commercial building property, the basis of the property must be reduced by the amount of the deduction allowed. The person or organization that makes the expenditures for construction is generally the recipient of the allowed tax deductions. As recently clarified by an IRS ruling, the deduction for government-owned buildings might be taken by the building or system designer.

Review improvements made to existing facilities to determine if they qualify for the deduction. To the extent your company is planning to make improvements, consider doing so in qualifying property to maximize allowable deductions in the current year.

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