In communication issued on January 9th, the Pennsylvania Department of Revenue reminded taxpayers that e-Tides, the Department’s prior online tax filing system, will be retired on February 24, 2023. Pennsylvania’s new system, myPATH, commenced operation in late November. Taxpayers that have not established their tax accounts on myPATH should act now to ensure access to the new system.

A myPATH account is required to file returns and make payments for many taxes, including sales tax and employer withholding. In addition, W-2 and 1099 reporting is housed on the myPATH system and the deadline for W-2/1099 reporting is rapidly approaching on January 31, 2023.

In its communication, the Department discusses the myPATH account creation process and provides links to instruction videos and tutorials on myPATH. Taxpayers are advised to make the transition early to allow time to address any account issues and avoid the risk of missing filing deadlines.

The complete communication from the Department can be viewed here.

If you have questions on Pennsylvania’s transition to myPath or other SALT matters, please contact the HBK SALT Advisory Group at hbksalt@hbkcpa.com.

A court weighs in on non-qualifying activities and expenditures.

Are you considering taking advantage of a research and development (R&D) tax credit for your general construction (GC), or mechanical, electrical, and plumbing (MEP) company? Determining what qualifies can be challenging. A recent U.S. District Court summary judgment against a construction industry taxpayer illustrates the complicated and strict rules for which activities and expenditures do and do not qualify for the credit.

Overview

R&D tax credits are designed to incentivize spending in the U. S. on research and development activities. They are available to taxpayers in many industries, including for GCs and MEPs, as long as the business is seeking to develop new products or improve existing products and processes, and the related projects or activities involve a sufficient level of technical uncertainty.

To benefit, the taxpayer must have both qualifying research activities and qualifying research expenditures. For taxpayers in the construction industry, qualifying activities often involve the engineering and design of a project. But many other activities related to the construction, renovation, and expansion of a building can also qualify, including design reviews and experimentation with raw materials. Qualifying expenditures can include internal labor costs, including wages, as well as the cost of outside consulting.

Qualified research activities

As they relate to general construction, activities that typically qualify for an R&D tax credit include:

• Development of estimates based on designs provided by architects or engineers
• LEED and green initiatives
• Evaluation of engineering and construction methods for improvement in build time or overall performance and reliability
• Development of unique material transfer systems on project sites (e.g. crane design)
• Development of temporary support structures for active construction
• Testing and validation of new mechanical systems to solve technical uncertainties

For MEP companies, qualifying activities include:

• Design and development of HVAC systems for new or existing structures
• Development of unique heat exchange, humidity control, and air filtration solutions
• Improvement of energy efficiency via system design
• Design and development of electrical systems
• Architectural lighting design
• Design and development of plumbing systems
• Development of coolant delivery systems for refrigeration
• Development of pressurized air, water, and other substance distribution systems
• Design and development of sprinkler and fire protection systems

The court case: two factors

While there are many R&D qualifying activities and expenditures for contractors, a recent U.S. District Court ruling in United States v. Grigsby highlights two critical factors, “funded research” and “business component,” where related activities and expenditures were disallowed, resulting in a summary judgment against the taxpayer:

• Funded research, any research funded by a grant, contract, or otherwise by an individual or governmental entity, does not qualify for an R&D tax credit. That seems to imply that if you are paid to do the work, it will not qualify. However, there are two contractual requirements that determine whether the work is “funded”:
• Funded projects do not include amounts paid based on the success of the research. If you bear the economic risk of getting it right—if the project is unsuccessful, you will not get paid—then the work is not funded. For contractors, that often means that fixed-price or lump-sum contracts will qualify, but cost-plus or time-and-expense contracts will not.
• A taxpayer is eligible for the R&D tax credit only if it retains the rights to the research; if the contractor is eligible to reuse the results of the project without paying someone else, they have retained the rights.

Key concerns for contractors

United States v. Grigsby reveals some key concerns for contractors taking or considering taking an R&D tax credit. First, many GCs will find it difficult to meet the business component test related to qualifying research activities. However, MEP subcontractors, especially those doing design work, can often establish their business component as a product they are developing and evaluating with alternatives. Second, the terms of a contract are critical to determining whether the research is funded and therefore ineligible for the credit.

Given the high level of complexity associated with applying for the R&D tax credit, contractors should work with a qualified expert to identify their eligibility for, and calculation of, an R&D tax credit. HBK works with clients in many industries, including construction, to help them claim R&D credits. We can help you too. For more information, or to schedule a meeting with a Construction Industry tax specialist, call us at 330-758-8613, or email me at bdigirolamo@hbkcpa.com.

The Tax Cuts and Jobs Act (TCJA) provided 100 percent bonus depreciation for qualified property (generally new and most used property with a tax recovery period of 20 years or less) placed in service after September 27, 2017, and before January 1, 2023. But the window is closing. If there is no reversal, the bonus percentage depreciation will begin dropping by 20 percent per year in 2023 until it zeros out in 2027.

Given the scheduled changes, taxpayers wanting to claim 100 percent bonus depreciation will need to acquire and place in service qualified property before the end of 2022. The “placed in service” date is when the property is ready and available for use, for most acquisitions, the purchase date. But qualifying can be more complicated, specifically for newly constructed or manufactured property, and property acquired but not used during the tax year. You should consult your tax advisor if you’re uncertain whether or not your property acquisition will be eligible for the bonus in 2022.

Should you acquire property before the end of 2022?

Accelerating tax deductions and deferring income is a common yearend tax planning technique, including acquiring property and claiming bonus depreciation. With the scheduled annual decline in bonus depreciation, the decision whether or not to acquire this year versus next presents itself with some sense of urgency. Should you rush to acquire property before the end of the year?

It depends. Lowering your tax bill should not be done at the expense of higher taxes over multiple future years; the best tax plans consider projected tax bills for years to come.

IRS Section 179

You should also consider whether IRS Section 179, another accelerated depreciation provision, will allow you to take an immediate deduction. Section 179 will not expire at the end of 2022; you can continue to use its expensing option for acquired property in the future. That said, Section 179 rules can make for very different outcomes than bonus depreciation at both federal and state levels. Your tax advisor should consider, and advise you, on the availability of Section 179 before you decide whether or not to acquire property before the end of the year.

The benefits of bonus depreciation will begin shrinking with each coming New Year, but the decision to acquire property this year or next depends on many factors. Consult with your tax advisor and consider your tax multi-year tax liability as well as the opportunity to use Section 179 before buying.

We can help. For more information, please reach out to your HBK Tax Advisor.

The Tax Cuts and Jobs Act of 2017 (TCJA), signed into law by then President Trump, resulted in the biggest changes to the Internal Revenue Code since the Reagan administration’s Tax Reform Act of 1986. Over the last four years, American businesses and individuals have enjoyed many of the tax benefits TCJA provided and have become accustomed to that new normal in their business and personal finances. Yet, while most American business owners are preoccupied with running their businesses amidst supply chain interruptions and runaway inflation, not to mention taking care of their families, they might not notice that the sun is beginning to set on many of the most impactful provisions of TCJA.

Each year since TCJA went into effect in 2018, a handful of narrowly applied provisions have expired including a tax credit for advanced nuclear power facilities at the end of 2020. Meanwhile, residential and business solar energy credits that were originally set to expire in 2021 have been extended and are now scheduled to expire starting in 2024. And while many benefitted from these credits, even more contractors and other businesses utilizing heavy equipment have benefited from 100 percent bonus depreciation. Since 2018, businesses have been able to fully expense their equipment and vehicle purchases in the year those assets were placed in service. At the end of 2022, that provision will begin to sunset, 20 percent annually until it reverts to pre-TCJA rules for depreciation after 2026.

Several excise taxes will also expire at the end of this year, including taxes on sales of heavy highway vehicles and heavy truck tires, and fuel taxes that were designated for the Highway Trust Fund. The annual use tax on heavy highway vehicles is then set to expire in 2023. And while the Infrastructure Investment and Jobs Act, passed in February 2022, includes funding to keep the Highway Trust Fund from insolvency, or at least delay insolvency until 2027, through general revenue transfers to make up the shortfall in permanent revenue sources, the Fund will require a more permanent fix to remain solvent beyond 2027.

No significant TCJA provisions are set to expire in 2024, but 23 provisions are scheduled for expiration in 2025, most notably, the reduction in individual income tax rates and the 20 percent deduction on qualified business income for pass-throughs. Increases in the child tax credit, the standard deduction, and the Alternative Minimum Tax (AMT) exemption included in the TCJA are also set to expire in 2025. Taxpayers have benefited immensely from these provisions and will certainly feel the impact if they are allowed to expire as currently scheduled.

Without action by Congress and the President, most American taxpayers will see a significant tax hike after the expiration of these and other provisions of TCJA. While the Biden Administration has been largely unsuccessful in advancing any of its tax initiatives to date, history reminds us that Washington often waits until the eleventh hour to address expiring tax provisions. That makes it difficult for business owners and individual taxpayers to plan in the interim—and even more important to consider the potential impact of these expiring provisions on cash flow when budgeting for the next few years.

For more information or to talk with an advisor about the potential impact of expiring provisions on your firm’s bottom line, contact an HBK Construction Solutions advisor at 239-263-2111; or email me at bdougherty@hbkcpa.com.

On April 26, 2022, the IRS issued proposed regulations that may impact some gifting strategies taxpayers have been using in order to use the increased estate exclusion amount before it is set to decrease in 2026.

Background. In 2017, Congress amended Internal Revenue Code (IRC) § 2010(c)(3) to increase the estate exclusion amount to $10 million per person, adjusted annually for inflation. The increase is set to expire on January 1, 2026, which will result in the estate exclusion amount reverting back to $5 million per person, adjusted annually for inflation. In 2019, the IRS issued final regulations establishing a “special rule” that ensures that a donor’s estate will not be taxed on completed gifts that used the increased estate exclusion amount, even if the donor passes away after the estate exclusion amount has reverted to the lower amount.

This “special rule” did not address a distinction made in the internal revenue code between “adjusted taxable gifts” that are completed gifts not includible in the donor’s gross estate for estate tax purposes, and completed gifts that are treated as testamentary transfers includible in the donor’s gross estate for estate tax purposes.

New Proposed Regulations. The new proposed regulations adjust the “special rule” to only apply to completed gifts that are not includible in the donor’s gross estate for estate tax purposes. By making this distinction, the IRS effectively limits some planning opportunities that taxpayers have taken advantage of in order to use the increased estate exclusion while still retaining an interest in the assets that have been gifted.

One planning opportunity that many have taken advantage of is gifting a fully enforceable loan where the donor promises to pay the donee an amount sufficient to use the increased estate exclusion. By making a gift of a loan, it enables the donor to make payments over time with a balloon payment due at death, instead of making a large gift of cash or other property immediately. The proposed regulations specifically highlight this planning opportunity, indicating that it would fall under the exception to the “special rule” and therefore only the estate exclusion available at the donor’s death would be applied. Here’s the example:

Assume that when the basic estate exclusion amount was $11.4 million ($10 million adjusted for inflation), a donor gifted an enforceable $9 million promissory note to their child (i.e. a promise to pay their child $9 million). This transfer constituted a completed gift of $9 million.

On the donor’s death, the assets that are to be used to satisfy the note are part of the donor’s gross estate, with the result that the note is treated as includible in the gross estate for purposes of IRC § 2001(b). Thus, the $9 million gift is excluded from adjusted taxable gifts in computing the tentative estate tax under IRC § 2001(b)(1).

Nonetheless, if the donor dies on or after January 1, 2026, the credit to be applied in computing the donor’s estate tax is the credit based upon the basic estate exclusion allowable as of the donor’s date of death ($6.8 million).

Another planning opportunity that many have taken advantage of, and that the IRS has consistently scrutinized, is the use of family-limited partnerships. The IRS has been known to challenge transfers of discounted limited partnership interests by arguing that the donor retained control over the family limited partnership. Where the IRS has been successful in these challenges, the value of the transferred limited partnership interest is included in the donor’s gross estate for estate tax purposes. The “special rule” of the proposed regulations would apply to these situations, giving the IRS a greater incentive to challenge family limited partnership interest transfers.

The proposed regulations can be found here.

Conclusion. The IRS is still seeking comments on these proposed regulations, and it is possible that there will be adjustments prior to the regulations becoming final. If you have taken advantage of the above strategies, or a gifting strategy that is similar, we encourage you to reach out to your HBK tax advisor to discuss the impact these proposed regulations may have on your overall estate plan.

Effective April 1, 2022, the following jurisdictions in Ohio will increase their sales and use tax rates:

• Coshocton County 7.75% from 7.25%
• Mahoning County 7.50% from 7.25%
• Lucas County and City of Rossford are part of The Toledo Area Regional Transit Authority (TARTA) which enacted 0.50% sales and use tax. The rate in Rossford, Wood County will be 7.25% an increase from 6.75%. The rate in Lucas County increases to 7.75% from 7.25%.

Taxpayers should ensure that the rate changes are accurately reflected in their systems so that customers are charged the appropriate sales tax rate. This may include retailers updating cash registers and point-of-sale software and systems. It is a good practice to review sales on the effective date of the rate change to confirm systems are properly calculating the tax. In addition, businesses need to update their use tax rates in order to capture the rate increases when self-assessing use tax in these jurisdictions. Use tax rates are typically updated in a firm’s accounting software or ERP system.

Additional Ohio sales and use tax rate information can be found here.

I am happy to answer further questions regarding how this increase may affect you or your business. Please contact HBK’s SALT Advisory group at HBKSalt@hbkcpa.com.

Ohio residents that worked from home in 2021 because of the pandemic may be entitled to a refund of municipal income tax. When COVID-19 struck, employees were often forced to work from home instead of their employer’s office (or principal place of work). In 2020, Ohio passed a temporary provision requiring employers to continue withholding municipal income tax from employees based on their office location even though employees were no longer working at the office.

Effective January 1, 2022, Ohio passed a new law allowing employees to obtain refunds for 2021 based on where they worked during the calendar year. However, the law does not address the withholding issue for 2020 due to pending litigation. Read more here.

For 2021, the difference in municipal income tax rates between an employee’s home and office (principal place of work) may result in a refund opportunity for employees that had local tax withheld at a higher rate – which is often the case for employees that work in Columbus or Cleveland or other high-rate cities but live in a lower rate municipality.

The Regional Income Tax Agency (RITA) which administers the local income tax for hundreds of Ohio municipalities has issued guidance on their website for employees seeking refunds – https://ritaohio.com/Individuals/Home/Refunds. The RITA website has an FAQ on refunds that addresses questions of timing and how to handle refunds from a municipality of employment when additional tax is owed to a municipality of residence.

Individual taxpayers should evaluate their work situations and tax withholding in 2020 and 2021 to determine if a refund is warranted. Those with the greatest opportunity for refund will be employees that worked from home in a low or no tax municipality. Refunds for 2020 will not be processed while litigation is pending, but taxpayers need to file refund claims before the statute of limitations expires (three years from the date tax was due/paid). Please contact HBK’s SALT Advisory group at HBKSalt@hbkcpa.com with questions.

In recent years the IRS has had great success in attacking micro-captive insurance companies using §831(b) principals in recent cases of Reserve Mechanical Corp v. Commissioner, Avrahami v. Commissioner, and Syzygy Ins. Co. v. Commissioner. These cases are extremely relevant to taxpayers using §831(b) captives that participate in risk pools to achieve risk distribution. With the IRS success in these cases, the use of §831(b) captives has been cautioned and, in many cases, exited.

Some general reasons these cases favored the IRS were:

1. Circular loans to shareholders or insured


2. Unreasonably priced policies


3. Lack of third-party insurance costs reductions


4. Lack of claims


5. Lack of claim probability


6. Reinsurance pools that didn’t represent adequate risk


7. Compromised feasibility and actuarial studies

Based on the IRS’s actions, the use of these micro-captive arrangements have declined substantially and have taxpayers wondering what facts, if any, would be acceptable under §831(b) in the eyes of the IRS.

In the past, various factors have been suggested to assist in the validity and success of these arrangements, but the IRS has continued to attack the arrangements. The following are some of the factors that have been positive micro-captive characteristics in the past.

1. Taxpayers with gross receipts of $50 million – $100 million


2. Paying significant premiums


3. Captive decreases commercial insurance costs


4. Having 1,000 or more employees


5. Using captive for “first dollar” insurance, as opposed to only insuring excess risk


6. Paying significant claims


7. Unrelated actuarial professionals from any managers


8. Using the captive to ensure risks like:

   a. Health insurance

   b. Workers’ compensation

   c. First-party warranties

   d. Professional liability

   e. General liability

   f. Accounts receivable

   g. Client loss



9. Have a safe harbor number of entities (8-12) or have significant risk exposure units to insure


10. Exiting risk pools

The IRS has been accumulating information on micro-captives since the issuance of Notice 2016-66 which required all captives, insured, and various related parties to disclose the captive as a transaction of interest on Form 8886 annually. The IRS has also sent out Letter 6336 to many taxpayers with these arrangements encouraging amending returns and other responses.

However, in a change of fortune for taxpayers, there has been a more favorable result in the case of Paul Puglisi and Ann Marie Puglisi v. Commissioner.

On October 29, 2021, the United States Tax Court accepted the IRS’s concessions of the vast majority of taxes and penalties associated with disallowed deductions for insurance premium payments made to §831(b) Oxford Insurance Company LLC Series A and the reinsurance company Series KF of Oxford Insurance Company. These Series received premiums from hundreds of other unrelated taxpayers.

Per the Case background, Puglisi Egg Farms of Delaware LLC purchased insurance against the fortuitous risk that was unavailable on the third-party market such as avian flu.

The IRS disallowed premiums in 2015-2016 and 2018 stating lack of §162 business purposes, lack of economic substance, and sole purpose to avoid taxes.

Since 2015, the insured Puglisi Egg Farms of Delaware LLC filed five substantial claims for losses covered via the captive.

The IRS assessed tax and penalties under §6662, but for undisclosed reasons conceded nearly all the tax and penalties prior to going to trial. The court, therefore, did not give an opinion on the validity of the captive itself. This unfortunately does not help taxpayers in the quest for clarity regarding micro-captives. However, it is a victory for the taxpayer, as the taxes and penalties for the most part were conceded.

What characteristics and circumstances caused the IRS to make this decision were not covered in the case, as the bulk of the exposition focused on whether or not the Court could accept this concession. On, the other hand, there was clearly a reason for the concession. Could any of the positive factors listed above be reasons the IRS conceded?

We will continue to monitor this and other cases to see if additional clarity in the micro-captive arena is achieved. Until then, micro-captives are an area most practitioners strongly counsel against with emphasis being on alternative insurance arrangements.

Taxpayers who recently moved, changed domicile, or recently changed filing status in a state may receive a residency audit notice from that state. These notices can be quite daunting, as residency audits are notorious for being long and arduous processes. Taxpayers must prove to the state that their filing status and residency within or outside of that state is legitimate to avoid unnecessary tax implications. The purposes of these audits are to prove that the asserted filing status is correct, taxpayers may be filing as nonresidents, part-year residents or full residents of a state.

Many states are notorious for their residency audit teams such as California, Connecticut, New Jersey, and New York however, due to the current nationwide deficits experienced by states due to the COVID-19 Pandemic, we anticipate more states to keep residency issues in their sights. We expect this to be an issue especially when taxpayers are moving from a high-income state to a low- or no-income state such as Arizona, Florida, Nevada, Tennessee, Texas, and Wyoming.

In addition to residency audits being a great way for states to recoup lost revenue, with the many changes due to the COVID-19 Pandemic, taxpayers have been moving away from large urban cities and relocating to new states all together. The influx of residency changes provides ample opportunity for taxpayers to assess their audit readiness and prepare themselves for a potential residency audit.

Domicile and Statutory Residency

Taxpayers can only have one domicile at a time, and a domicile remains intact until a new one is established, this means that once a state becomes a taxpayer’s domicile, that state will continue to be the taxpayer’s domicile until all ties have been cut and the new state has fully been adopted as the state of domicile. Domicile is typically where a taxpayer’s permanent home is (though not always), where the taxpayer intends to remain on a permanent basis and where the taxpayer keeps all items near and dear to them and spends the majority of their time. Domicile is a primarily subjective test, and the state will weigh each of these factors, though no single factor is determinative, However, the first four factors listed below are typically scrutinized more heavily. When analyzing domicile, we typically ask taxpayers which state the following items are in:

• State where near and dear personal property is located
• State where children and/or spouse are located
• State where real property is owned and used
• Business ties to the state in question

Other items

• State where vehicles/other property is titled and plated
• State of voter registration
• History of employment in the state
• State where doctors and other medical professionals are located
• State where other professional advisors are located
• Location of social clubs
• Location of charitable activities
• State of licensure
• Whether a declaration of domicile has been filed or a residence homesteaded

While this information comes off as intrusive and personal in nature, states have been known to interview friends, family and even doormen, request personal logs of days activities, obtain and review credit card statements, cell phone records and e-toll logs, request copies of airline tickets and moving receipts, analyze social media accounts, visit the real property locations to investigate and request additional information concerning corroboration of out of state activities.

In addition to this question of domicile, states will look to the number of days, or contact periods, that you have within their borders to see if a taxpayer has met the standards for “statutory residency.” A statutory resident is one who has been within the state and has generally spent more than 183 days or contact periods within that state. For many states, a contact period or a day is counted even if the taxpayer was only in that state for mere moments or hours, it does not necessarily require that the taxpayer spend the night in that state. In many states this is known as the 183-day test, if a taxpayer has more than 183 days of contact or activity within a state (other than travel through the state for international or interstate destined travel or certain medical confinements), they will be considered a statutory resident and have to file a resident return for the state. This is especially concerning in a COVID-19 world where many taxpayers are relocating or working remotely during the pandemic.

For taxpayers engaged in repeated travel into numerous states, those with vacation homes in other states or those that are temporarily located in another state it is critical that you track your travel plans, dates within each state and expenditures from within each of the relevant states relating to this travel. This will assist in proving that the 183-day test has not been met.

Likelihood of Audit and Audit Procedure

Depending on the states at issue the risk for a residency audit can be quite high. New York for instance is said to have over 300 auditors in their residency division that solely focus on issues of residency and income tax. This has allowed New York to generate over $1 billion in revenue over a five-year period. In states like California, the Board of Equalization is notorious for dragging some residency audit appeals out for decades and has ruled against taxpayers in residency audits on factors including the maintenance of a PO box in the state where mail (including the audit notice) was still being sent to and collected from. Even taxpayers who have moved abroad have fell victim to a California residency audit, with the state taking the position in many instances that travel and employment abroad were not sufficient to break an already established domicile within the state.

Residency audits can be long, detailed, and invasive processes, especially in instances where the taxpayer has left a high-income tax state and moved to a low- or no-income tax state. If you receive a notice of an intent to audit specifically over filing status involving residency, you should expect that these audits may take upwards of 6-9 months to fully resolve if all goes smoothly. If negotiations or appeals come into play the residency audit can be dragged out for well over a year.

During this time, a detailed analysis will be undertaken by your tax professionals as well as by the state auditors to assess every contact period and day spent in the auditing state. Although this inquiry may feel very invasive, personal information may need to be turned over to support and defend a position of residency. It is important to understand the entire impact of a residency filing position taken on a return. Not only will a change in residency under audit impact your income taxes in that new residency state, but the taxpayer may also still face income tax and residency status issues in the secondary state. This could drastically alter a taxpayer’s estate plan and impact their property if they are located in a home rule state. Depending on the year under audit and the outcome, the impact of an assertion of residency under audit could alter future tax years or years outside of the audit period. Remember, domicile once established requires affirmative steps to abandon and reestablish in a new state. This can cause issues for taxpayers when older tax years are audited, but there has been no substantial change in facts for all subsequent years resulting in the findings of that audit to potentially carry into all future years.

While no one wants to deal with an audit, a residency audit by a state can be a tiresome process. It is critical that you develop a plan and work with your HBK advisors to ensure that you are maintaining proper documentation regarding residency. This is especially important for taxpayers who have recently sold or planning on selling a business, moved, are planning on moving or are temporarily located in another state due to the COVID-19 Pandemic. Without proper planning and documentation, a taxpayer actually runs the risk of have multiple residencies and inadvertently increase the income tax filing obligations they have across the US. If you have received notice of an intent to audit due to residency by a state, please do not hesitate to contact your HBK Advisor to get this matter resolved quickly and favorably.