Spring 2013 issue of Horizons

RubinBrown's Spring 2013 issue of Horizons covers how tax regulations affect your firm. The issue features the impact of the new Medicare tax and private company financial reporting.

horizons A publication by RubinBrown LLP Spring 2013

PLUS

The Impact of the New Medicare Tax

Private Company Financial Reporting

Tax Planning Strategies for Company Aircraft

TABLE OF CONTENTS

horizons A publication by RubinBrown LLP SPRING 2013

Features

1 2 4

Welcome from the Managing Partner

RubinBrown News

Chairman’s Corner

Chairman James G. Castellano, CPA

6 10 14 57

The Impact of the New Medicare Tax

Managing Partner John F. Herber, Jr., CPA

Private Company Financial Reporting: Building the Infrastructure for the Future

Denver Office Managing Partner Gregory P. Osborn, CPA Kansas City Office Managing Partner Todd R. Pleimann, CPA

Tax Planning Strategies for Company Aircraft

Timely Reminders

Industry-Specific Articles

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colleges & universities Regulatory Assessment of Private Institution’s Financial Responsibility The NAICU made formal recommendations for the Department of Education to consider regarding the financial responsibility test. public sector How Recent Changes in Auditing Standards Will Impact Governmental Entities An explanation of SAS 122, SAS 125 and additional Yellow Book standards. Value-Added Versus Non-Value-Added Expenses Identifying which costs to keep and eliminate can help manufacturers improve bottom-line results.

professional services

real estate Tax Reform’s Unintended Impact on Affordable Housing Development One LIHTC project is a shining example of the positive impact on a community and what could be lost. life sciences Tax Changes & Valuation Issues Unique to the Life Sciences Industry Because Life Sciences companies are often in earlier stages, additional tools may be used to help more accurately value the company. construction Impact of New Tangible Property Law on Construction Companies Helping construction companies determine how tangible property expenditures should be categorized.

Editor Dawn M. Martin

Market Sourced Apportionment for Professional Services Firms Income tax considerations for service- oriented organizations when crossing state lines for business. A Recap from the 2013 RubinBrown Not-For-Profit Update An overview of financial reporting trends, FASB update, tax topics and more. hospitality & gaming Commercial & Tribal Gaming Revenues Reach All-Time High in 2012 While the expansion of gaming has benefited the industry as a whole, it has also created a highly not - for - profit

Art Director Jen Chapman

Horizons, a publication of RubinBrown LLP, is designed to provide general information regarding the subject matters covered. Although prepared by professionals, its contents should not be construed as the rendering of advice regarding specific situations. If accounting, legal or other expert assistance is needed, consult with your professional business advisor. Please call RubinBrown with any questions (contact information is located on the back cover). Under U.S. Treasury Department guidelines, we hereby inform you that any tax advice contained in this communication is not intended or written to be used, and cannot be used by you for the purpose of avoiding penalties that may be imposed on you by the Internal Revenue Service, or for the purpose of promoting, marketing or recommending to another party any transaction or matter addressed within this tax advice. Further, RubinBrown LLP imposes no limitation on any recipient of this tax advice on the disclosure of the tax treatment or tax strategies or tax structuring described herein.

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manufacturing & distribution

Readers should not act upon information presented without individual professional consultation.

competitive regional market, particularly along state borders.

WELCOME FROM THE MANAGING PARTNER

Thank you for your business!

Tax season means many different things to us here at RubinBrown.

While it was, indeed, a very busy time for us, it also presented the best opportunity to connect once again with our clients as we finalized their personal and corporate tax returns. During the first few months of this year, I saw many long-time clients stop in for meetings, pick up returns, and do business out and about in the marketplace. The hustle and bustle of activity within all three of our offices in St. Louis, Kansas City, and Denver during this busy time gave me pause and provided a unique perspective. It is clients like you—many of whom have been fiercely loyal to us for many years—that make working each and every day a true blessing. There’s nothing more satisfying than serving as the trusted advisor for you, your families and businesses.

John F. Herber Jr., CPA Managing Partner

It’s a competitive market in the accounting profession. We know you have choices.

We are honored that you have selected and stayed with RubinBrown.

Our top priority is superior quality and service to you. And we are steadfast in our commitment to earning your business now and in the years to come. I would welcome your feedback on ways we can continue to deliver “totally satisfied clients.” Please email me directly at john.herber@rubinbrown.com.

Pleasant reading,

www.RubinBrown.com | page 1

RUBINBROWN NEWS

NFL Veteran Aeneas Williams Presents To RubinBrown Team

RubinBrown team members were honored to hear from former NFL Player Aeneas Williams who traveled to all three of our locations for our recent Team Member Updates. RubinBrown team members enjoyed his anecdotes and words of wisdom about “Reaching Your Potential,” which provided for inspiring and often humorous presentations.

NFL Veteran Aeneas Williams (third from left) with Denver Office Managing Partner Greg Osborn (far left), Firm Managing Partner John Herber, and Kansas City Office Managing Partner Todd Pleimann (far right).

RubinBrown Team Member Scores Third Highest on CPA Exam in Kansas RubinBrown’s Patrick Amos was recently recognized by the Kansas State Board of Accountancy for having the third highest score on the CPA exam throughout the state of Kansas. Amos works in the Assurance Department in our Kansas City office.

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RubinBrown New Hires Partners Matt Beerbower joined the Denver Office as a partner

Jason Uetrecht joined RubinBrown’s St. Louis office as a partner in the firm’s Wealth Management Services Group. Uetrecht specializes in individual, trust and estate tax consulting,

in the Assurance Services Group. He serves clients in the construction, real estate, manufacturing and distribution, technology, governmental and not-for-profit industries. RubinBrown added Darin James as a partner in the firm’s Tax Consulting Group in the Denver Office. James specializes in serving corporate tax clients that have significant global operations with the management of a variety of domestic and international tax issues.

planning and preparation, family business and succession planning, IRS examination matters, and family financial planning.

Managers

RubinBrown recently added Tanna Curtin as a manager in the Denver Office’s

RubinBrown added James Grimes to our St. Louis Business Advisory Services Group. Grimes provides internal audit and accounting controls, risk-based audit planning,

Assurance Services Group. With more than a decade of experience, Curtin works with clients primarily in the not-for-profit, public sector and real estate industries.

Sarbanes Oxley consulting, and forensic and fraud investigation services for clients in the manufacturing and distribution industry.

RubinBrown recently added Shannon Gilbert as a manager in the Denver Office’s Tax Services Group. Gilbert’s areas of specialty include tax consulting, IRS

Deborah Hood recently joined RubinBrown’s St. Louis Office as a manager in the firm’s Tax Services Group. Hood specializes in property and state and local tax matters.

examination matters, tax return preparation and planning and project management.

Jason Soodsma is a new manager in RubinBrown’s

RubinBrown added Martin Gold as a manager in the Denver Office’s Tax Services Group. Gold specializes in tax consulting and compliance, particularly for C corporations.

Assurance Services Group in the Denver Office. Soodsma specializes in audits, reviews, compilations, financial reporting and taxes for S-Corp, C-Corp, partnerships and individuals.

www.RubinBrown.com | page 3

CHAIRMAN'S CORNER

Wealth Management and Income Taxes: What’s the Connection? by Jim Castellano, CPA

W hile CPAs provide a broad array of services today, chances are if you meet a CPA, the first thing you think about is income tax. It happens to me all the time. Sitting next to someone on an airplane, the conversation usually goes something like this…

Fellow passenger says, “Hello, what do you do?”

My answer, “I am a CPA.”

To which fellow passenger replies, “Oh, you must be busy now since it’s tax season. Let me ask you a question, can I deduct the cost of my hot tub as a medical expense?”

My answer, of course, “It depends.“

Jim Castellano, CPA Jim Castellano is Chairman of the Board of RubinBrown LLP. He joined RubinBrown in 1973 and has served at the helm since 1989. Jim’s influence extends beyond the firm to the accounting profession as a whole. In addition to his leadership role at RubinBrown he also serves as Chairman of Baker Tilly International, the world’s eighth largest network of independent accounting firms.

Income tax services have been offered by RubinBrown from the time of our founding. Today, I am very proud that we have the finest tax talent the profession has to offer, some of whom are featured authors in this edition of Horizons . But income tax is but one topic that individuals should consider as part of a broader wealth management plan. Our mission at RubinBrown is to “help clients build and protect value,” and we have created a wealth management process structured to do just that.

The process provides the discipline necessary to enable clients to establish and prioritize meaningful goals, develop plans to achieve them, and monitor progress along the way. Our Wealth Management and Family Office Services are provided by trusted professionals, experienced in taxation, investments, financial and estate planning. Their approach is highly integrated so that the work of all of the client’s financial advisors is fully coordinated by the RubinBrown team. This way, clients benefit from the knowledge and wisdom of their entire team of advisors.

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Clients count on independence and objectivity from our team. We are fee-based advisors and our client’s best interest is foremost in all that we do. Our wealth management team is highly networked in the communities we serve and is an invaluable resource for clients who turn to us first for recommendations to satisfy a variety of their needs. The RubinBrown wealth management process is a continuous, disciplined, highly successful methodology that includes these steps:

100th birthday of the United States Income Tax

The income tax was established in the United States when the 16th Amendment to the Constitution was ratified in October 1913.

At that time, the first Form 1040 was created.

No doubt the complexity of the income tax system has increased dramatically over the last 100 years, as has the income tax rate!

∙ Establishing and defining the relationship with the client

∙ Gathering relevant data and facilitating the establishment of client financial goals

∙ Analyzing the data and assessing the client’s financial position

∙ Developing recommendations for achieving the goals

∙ Implementing the recommendations in collaboration with the client

∙ Monitoring the progress of recommendations and their results

Minimizing the client’s effective income tax cost is almost always one of the goals, but as you can see, while an important element of the process, it is not the only part. So perhaps next time I am asked “What do you do,” I should respond, “I am a CPA who helps clients build and protect value by employing our disciplined wealth management process.” I suspect that response may lead to several possible results…abruptly end the conversation, or begin an engaging discussion about financial planning, or lead to a follow up question…”Great, so can I deduct the cost of my hot tub as a medical expense?”

www.RubinBrown.com | page 5

FEATURE

The Impact of the New Medicare Tax by Bob Jordan, CPA

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While many taxpayers were anxiously keeping an eye on Congress toward the end of 2012 to see if any last minute action would raise their taxes in 2013, the Patient Protection and Affordable Care Act (“ACA”) enacted in 2010 was already poised to do just that. The ACA calls for a 3.8% surtax on the lesser of net investment income or the amount by which modified adjusted gross income exceeds certain levels. Separately, taxpayers with wages or self employment income above certain levels will also see a rise of 0.9% on the excess.

To those taxpayers that breathed a sigh of relief when they saw that the provisions of the newest law were aimed at taxpayers in the $400,000 plus range, you’re not out of the woods yet.

3.8% Medicare Tax on Investment Income This new tax will only affect taxpayers who have investment income and whose adjusted gross income (AGI) exceeds:

∙ $250,000 for joint filers and surviving spouses

∙ $200,000 for single taxpayers and heads of household

∙ $125,000 for married individuals filing separately

Rather than measuring your income by using a taxable income standard (income after deductions), this rule essentially looks at your total income. While you may see the term “Modified Adjusted Gross Income” used, the only modification is the foreign income exclusion. For the vast majority of taxpayers then, the measurement will be the bottom line on Page 1 of their Form 1040.

If your AGI is above the applicable threshold, the 3.8% tax will apply to the lesser of either:

∙ Your net investment income for the tax year

∙ The excess of your AGI for the tax year over your threshold amount

This tax is on top of any income tax you are already paying on that income.

Let’s look at three examples to illustrate how this works. We’ll use taxpayers with a married filing joint status so their thresholds would each be $250,000.

$250,000

Although Taxpayer C has far more investment income than the other two taxpayers, he is not subject to the tax because the total income does not exceed the threshold. Only $10,000 of the investment income is subject to the tax because the total income exceeds the threshold. Additional tax = $380 ($10,000 x 3.8%). All of the investment income is subject to the tax because the regular income exceeds the threshold. Additional tax = $1,520 ($40,000 x 3.8%).

Taxpayer A

$260K

$40K

Taxpayer B

$220K

$40K

Taxpayer C

$250K

regular (non-investment) income

investment income

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FEATURE

Net Investment Income Explained Net investment income that is subject to the 3.8% tax includes: interest, dividends, annuities, royalties, rents, and net capital gains, other than such income which is derived in the ordinary course of a non-passive trade or business. However, passive activity business income is subject to the tax. Net capital gains include the gain on a sale of a residence only to the extent that it is not excluded by other provisions in the tax code. For example, while other factors can reduce the excluded amount, the normal gain exclusion on the sale of a principal residence is $500,000 for married filing joint taxpayers ($250,000 for other taxpayers). If the gain is excluded under those provisions, it is excluded for the 3.8% tax as well. Remember, however, that the exclusion provisions don’t apply to sales of vacation homes or other second residences. Rule of thumb here, if the housing gain is subject to regular capital gains taxation, it’s also subject to the 3.8% tax. Income that does not bear the 3.8% tax includes: tax-exempt bond interest, retirement plan distributions, IRA distributions, Social Security payments and, of course, any earned income such as wages or self- employment income (although earned income above certain thresholds may be subject to a separate 0.9% tax). It’s not only the investor that is targeted by increased Medicare tax. Also new for 2013, some high wage earners will pay an extra 0.9% Medicare tax on a portion of their wage income. This is on top of the 1.45% Medicare tax that they are already paying. The 0.9% tax applies to wages in excess of $250,000 for joint filers, $125,000 for married individuals filing separately, and $200,000 for all others. The 0.9% tax applies only to employees, not to employers. 0.9% Medicare Tax on Wage and Self-Employment Income

Oddly increasing the “marriage penalty” for joint filers, the additional tax applies to the spouses’ combined wages. For example, suppose that a married couple each earns $150,000 for a combined amount of $300,000 in 2013. If single, neither would pay the additional tax; however, because they are married they will pay 0.9% on $50,000 of their combined wages. In this instance, the tax will be paid by adding it to their tax return for the year. If an employee’s wages reach $200,000 for the year, the employer must begin withholding the additional 0.9% tax from the wages. This withholding could either end up in two situations. First, if the withholding is in excess of a married employee’s liability, the employee will claim a refund on the tax return for that year. For example, if the employee earned $240,000, 0.9% would be withheld on $40,000. But if the spouse did not work, no liability would result because the total wages would not be $250,000. Alternatively, the withholding may prove insufficient if the employee has additional wage income from another job or if the employee’s spouse also has wage income. In this case, the tax would have to be paid with the tax return. The extra 0.9% Medicare tax also applies to self-employment income for the tax year in excess of $250,000 for joint filers, $125,000 for married individuals filing separately, and $200,000 for all others. This 0.9% tax is in addition to the regular 2.9% Medicare tax on all self-employment income. The $250,000, $125,000, and $200,000 thresholds will be reduced by the taxpayer’s wage income. While self-employed individuals can claim half of their self-employment tax as an income tax deduction, the additional 0.9% tax won’t generate any income tax deduction.

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Planning Strategies While the addition of a 3.8% tax on investment income generally shouldn’t warrant wholesale changes to an investor’s portfolio simply to avoid the tax, it is perfectly logical to take a second look at certain investments in relation to their alternatives. Muni bonds, for instance, typically factor their tax-free status into their pricing. If as a result of this law, your after-tax rate of return has fallen, it may make sense to revisit your allocation to muni bonds if this change has not been completely priced into the return. In addition, growth stocks become slightly more attractive due to your ability to defer the tax into the future (or perhaps forever if you hold them to your death). Matching of gains and losses has a bigger payoff as well.

While retirement plan distributions are not subject to the tax, they do push up AGI which can subject more of your investment income to the tax. If you were on the fence with respect to a Roth conversion before, taking the hit one year and perhaps sparing future investment returns from the tax may push you over the line. Only by looking at your own unique situation can you determine if this additional drag on investment and earned income warrants any changes in action. While the amounts may seem fairly insignificant for some taxpayers, when you couple them with possible other income tax increases from the newest tax law change, a closer look would seem to make sense.

RubinBrown Tax Services Group The proactive and creative technical expertise of our tax consultants combined with our personal, long-term relationships with our clients distinguishes RubinBrown tax services.

Steve Brown, CPA – Saint Louis Partner-In-Charge & Chairman Tax Services Group 314.290.3326 steve.brown@rubinbrown.com

Mary Ramm, CPA – Kansas City Partner Tax Services Group 913.499.4406 mary.ramm@rubinbrown.com

Bob Jordan, CPA – Saint Louis Partner-In-Charge Wealth Management Services Group 314.290.3221 bob.jordan@rubinbrown.com

Tim Sims, CPA – Saint Louis Partner Tax Services Group 314.290.3434 tim.sims@rubinbrown.com

Jim Massaro, CPA – Denver Partner Tax Services Group 303.952.1211 jim.massaro@rubinbrown.com

www.RubinBrown.com | page 9

FEATURE

Private Company Financial Reporting: Building the Infrastructure for Future Regulation by David Duckwitz, CPA

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During 2012, the Financial Accounting Foundation (FAF), the oversight body of the Financial Accounting Standards Board (FASB), created a new advisory body in an effort to improve the standard- setting process for private companies. The FAF’s decision established the Private Company Council (PCC) which will have two main responsibilities. First, the PCC will determine whether exceptions or modifications to existing nongovernmental U.S. Generally Accepted Accounting Principles (GAAP) are necessary to address the needs of users of private company financial statements. Any changes proposed by the PCC will be subject to subsequent endorsement by the FASB and submitted for public comment before being incorporated into GAAP. In addition, the American Institute of Certified Public Accountants (AICPA) declared its support for the FAF’s decision to create the PCC. The AICPA also announced plans to develop another comprehensive basis of accounting or special purpose framework to meet the needs of some privately held small- and medium-sized enterprises (SMEs). The AICPA’s proposed financial reporting framework (FRF) is being developed by the AICPA staff and the FRF-SME Task Force and will not be acted upon by any AICPA senior technical committee or the FASB. The decision to apply the FRF for SMEs would be made by an entity’s management based on the entity’s specific circumstances. The AICPA’s FRF for SMEs exposure draft covers only broad recognition and measurement principles. Implementation guidance, in the form of application examples, illustrative financial statements, and disclosure checklists will be issued as a separate document accompanying the final FRF for SMEs. Although no specific timetable is being proposed for updates or revisions, the AICPA Task Force expects to review the framework and propose changes no more frequently than every three or four years. The AICPA expects to issue the final framework in late spring 2013. Second, the PCC will also be the primary advisory body to the FASB on the appropriate treatment for private companies for items under active consideration on the FASB’s technical agenda.

Some of the most significant recognition and measurement elements of the AICPA’s proposed FRF for SMEs that may differ from current GAAP are:

∙ The basic financial statements would include a balance sheet, income statement, statement of changes in equity, and a statement of cash flows. A statement of comprehensive income is not required. ∙ A choice could be made by a parent company either to consolidate its subsidiaries, or account for its subsidiaries under the equity method. In either case, all subsidiaries would have to be accounted for in the same way.

∙ Control of a subsidiary would be based entirely on ownership of more than 50%, without consideration of current GAAP’s concept of variable interest entities.

∙ In broad terms, lease accounting would be similar to current GAAP and the distinction between a capital lease and an operating lease would be retained. Such treatment differs from accounting for leases as proposed by the FASB.

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FEATURE

∙ Generally, the conditions for recognizing revenue would be consistent with current GAAP and not according to the revenue recognition standard proposed by the FASB. ∙ A choice could be made to account for income taxes under either the “taxes payable” method or the “deferred” method. The AICPA notes that the goal of the PCC and the FASB is to streamline accounting and reporting for private companies within the context of GAAP, whereas the FRF for SMEs is not GAAP and is intended instead for private companies that do not require GAAP-based financial statements. The PCC will determine whether exceptions or modifications to existing GAAP are necessary to address the needs of users of private company financial statements. The PCC held its inaugural meeting in Norwalk, Connecticut during December 2012. At the meeting, the PCC identified four initial areas to research for agenda consideration, as follows:

∙ Consolidation of variable interest entities

∙ Accounting for “plain vanilla” interest rate swaps

∙ Accounting for uncertain tax positions

∙ Recognizing and measuring, at fair value, various intangible assets (other than goodwill) acquired in business combinations While the PCC will also be considering other items, it was noted during the meeting that these four topics have consistently come up as potential issues for private companies with respect to financial reporting requirements. The initial agenda items stemmed from recommendations by constituents providing written input to the Blue-Ribbon Panel on Standard Setting for Private Companies in 2010 and by participants in private company roundtables held in 2010 and 2011. The PCC will expand discussions of these topics during 2013 in collaboration with the FAF and the FASB.

RubinBrown’s Assurance Services Group Your company will benefit from our highly trained professionals with experience in many industries. We utilize our renowned ViewPoints Report to bring value-added ideas and feedback while performing attest services.

Fred Kostecki, CPA – Saint Louis Partner-In-Charge Assurance Services Group 314.290.3398 fred.kostecki@rubinbrown.com

Bert Bondi, CPA – Denver Partner Assurance Services Group 303.952.1213 bert.bondi@rubinbrown.com

David Duckwitz, CPA – Kansas City Director of Quality Control Assurance Services Group 913.499.4433 david.duckwitz@rubinbrown.com

Todd Pleimann, CPA – Kansas City Managing Partner, Kansas City Office 913.499.4411 todd.pleimann@rubinbrown.com

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ABACUS Recruiting’s reputation for quality service stems from our industry knowledge, commitment to personalized service, confidentiality and dedication to maintaining the most ethical standards in the recruiting industry. Having successfully placed financial and business professionals in positions at Fortune 1000 companies, regional businesses and entrepreneurial firms, ABACUS Recruiting has become one of the most respected names in our industry. Whether you are a company in search of high caliber professionals or a candidate searching for a job change, ABACUS Recruiting is uniquely qualified to assist you.

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ABACUS RECRUITING IS AN AFFILIATE OF RUBINBROWN LLP

FEATURE

Tax Planning Strategi es for Company Aircraft by Jason Uetrecht, CPA, CFP

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There are many good business reasons for a company to own an aircraft or otherwise have access to one, and you may be among those who enjoy the benefits of avoiding TSA security lines, flying comfortably, and according to your own timetable.

In addition to the perks, companies can greatly benefit from the efficiencies achieved by owning or chartering a private aircraft.

But many companies, beginners and veterans alike, tend to overlook or mismanage an important aspect of tax planning, and a potentially expensive one as far as the IRS is concerned. You guessed it: failing to account properly for the income tax issues associated with personal travel. Last summer, the IRS issued final regulations with regard to the tax treatment of an employer with respect to certain personal use of an employer-provided aircraft. The final regulations adopt the 2007 proposed regulations with some notable additions and clarifications. Background IRC Section 274(a) does not allow deductions for activities considered to be entertainment, amusement, or recreation, unless they are directly associated with the active conduct of the taxpayer’s trade or business. There are several exceptions to the general rule. However, the application of these exceptions by taxpayers created a great deal of scrutiny from the IRS, especially with regard to personal use of an employer-provided aircraft. Prior to the law change, taxpayers have interpreted these exceptions such that if the employer included the value of the entertainment travel as compensation (calculated using the SIFL rules which value employer-provided flights on non-commercial aircraft) in the employee’s income, then the taxpayers would be able to deduct all of the expenses associated with the entertainment travel. However, the amount calculated under SIFL and included in income was normally a great deal less than the actual expenses associated with the entertainment travel (operating expenses and fixed costs, such as depreciation) that the taxpayers deducted. This discrepancy between the two amounts allowed the taxpayers to take a large deduction. The IRS contended that a taxpayer’s deduction should not exceed the amount of expenses that the taxpayer included in income under SIFL. The issue culminated with the tax court in Sutherland Lumber-Southwest, Inc. v. Commissioner where the court ruled against the interpretation of the IRS and in favor of the taxpayer. This was an enormous win because the taxpayer obtained a significant tax benefit from deducting 100% of the expenses of operating the aircraft despite a large use of the aircraft for entertainment travel. The IRS ultimately acquiesced in the finding. However, the American Jobs Creation Act of 2004 included a provision that repealed the ruling in the Sutherland Lumber Case for certain individuals. IRS Notice 2005-45 was the initial guidance used by taxpayers until the IRS issued the proposed regulations in June 2007.

www.RubinBrown.com | page 15

FEATURE

Final Regulations The final regulations provide that expenses for entertainment use of an employer-provided aircraft by a “specified individual” are disallowed except to the extent of the amount treated as compensation to the specified individual or to the extent that a specified individual reimburses the taxpayer for that flight. A “specified individual” is generally an officer, director, or more than 10% owner of an S, C, or personal service corporation (or for a partnership, any partner that holds more than a 10% equity interest in the partnership, general partner, officer, or managing member). Expenses Subject to Disallowance A taxpayer must take into account all the expenses of operating the aircraft (including all fixed and operating costs). These expenses include:

basis over the class life of an aircraft for all of the taxpayer’s aircraft for the current year and all future years when calculating the amount of disallowed expenses. This could help to reduce the disallowance, for instance, in a high personal-use year that is also an earlier year of ownership of an aircraft that is depreciated under more accelerated methods. Also, the final regulations provide that the basis of an aircraft is not reduced for the amount of depreciation disallowed by these rules. Another favorable provision applies to situations where an aircraft is leased out for third-party charter use. Many times a company that owns a plane, but does not use the plane to its maximum capacity, may wish to defray some of the aircraft’s operating cost by making the plane available for third-party charter use. Expenses allocable to a lease or charter of an employer’s aircraft to an unrelated third- party in a bona-fide business transaction for full and adequate consideration are not taken into account for purposes of the deduction disallowance calculation. Allocation of Expenses Among Various Uses to Determine Amount Disallowed The final regulations provide two methods to allocate expenses to personal entertainment flights provided to specified individuals. Whichever method is chosen, the taxpayer must use the chosen method for all flights of all aircraft for the taxable year. ∙ Occupied Seat Mile / Hour Method A taxpayer may allocate expenses for each taxable year using either occupied seat hours or occupied seat miles flown by the aircraft. In general, taxpayers must aggregate all fixed and variable expenses to determine the total expenses paid or incurred during the taxable year and divide the amount of total expenses by total occupied seat hours or occupied seat miles flown to determine the cost per occupied seat hour or occupied seat mile.

∙ Salaries for pilots

∙ Maintenance personnel and other personnel assigned to the aircraft

∙ Meal and lodging expenses of flight personnel

∙ Take-off and landing fees; costs for maintenance and maintenance flights; costs of on-board refreshments, amenities and gifts

∙ Hangar fees (at home or away)

∙ Management fees

∙ Cost of fuel, tires, maintenance, insurance, registration, certificate of title, inspection, and depreciation

∙ Interest on debt secured by or properly allocated to an aircraft

∙ Costs paid or incurred for aircraft leased, or chartered, to or by the taxpayer

The regulations contain a couple more favorable provisions with regard to depreciation. A taxpayer can elect to calculate depreciation on a straight-line

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∙ Flight by Flight Method A taxpayer has the option of allocating expenses on a flight-by-flight basis. Under this method, a taxpayer may aggregate all expenses for the taxable year and divide the amount of total expenses by the number of flight hours or miles for the taxable year to determine the cost per hour or mile. The taxpayer then will allocate expenses to each flight by multiplying the number of miles or hours for the flight by the expense per hour or mile and allocate expenses for the flight to the passengers on the flight per capita. When a trip contains flights that include both business and entertainment segments, the costs must be allocated between the two uses. The entertainment cost is the excess of the total expenses of the flights less the expenses of the flights that would have been taken without the entertainment leg(s).

Expenses incurred for non-entertainment personal travel of specified individuals aboard employer-provided aircraft are not subject to the disallowance provisions of the final regulations so long as such use is treated appropriately as compensation or reported as income to the specified individuals. For example, the final regulations provide that entertainment does not include travel to attend a family member’s funeral.

To calculate: Amount of the expenses allocable to the entertainment flight of the specified individual (using either the occupied seat hour or mile method or the flight-by-flight method) – Amount the taxpayer treats as compensation or reports as income to the specified individual (not below zero) + Any amount the specified individual reimburses the taxpayer Amount disallowed under Section 274 for a personal entertainment flight by a specified individual

RubinBrown Tax Services Group The proactive and creative technical expertise of our tax consultants combined with our personal, long-term relationships with our clients distinguishes RubinBrown tax services.

Steve Brown, CPA – Saint Louis Partner-In-Charge & Chairman Tax Services Group 314.290.3326 steve.brown@rubinbrown.com

Tim Sims, CPA – Saint Louis Partner Tax Services Group 314.290.3434 tim.sims@rubinbrown.com

Jim Massaro, CPA – Denver Partner Tax Services Group 303.952.1211 jim.massaro@rubinbrown.com

Jason Uetrecht, CPA, CFP – Saint Louis Partner Wealth Management Service Group 314.290.3283 jason.uetrecht@rubinbrown.com

Mary Ramm, CPA – Kansas City Partner Tax Services Group 913.499.4406 mary.ramm@rubinbrown.com

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REAL ESTATE

The North Sarah Apartments in St. Louis, Missouri are one of the newly constructed housing units funded in part by Low Income Housing Tax Credits (LIHTC). Photo courtesy of McCormack Baron Salazar.

Tax Reform’s Unintended Impact on Affordable Housing Development by Bryan Keller, CPA

W ith pending tax reform on the horizon and the fact that all tax expenditures will likely be called into question, could one of the most successful financing tools ever created to provide affordable housing and community development be in trouble? Developments in Missouri and across the nation could face additional challenges as many state Low Income Housing Tax Credits (LIHTCs) and housing programs are also receiving greater scrutiny under budget review.

Yet, looking at the newly constructed LIHTC project, North Sarah Apartments Phase I which is located in the 18th Ward, just north of Gaslight Square in St. Louis, Missouri, it is difficult to imagine the LIHTC program being eliminated or reduced. Indeed, one cannot underestimate the impact this property has had on families in the surrounding community striving to find safe, affordable quality housing. It’s almost as if the community was transformed overnight when the project was constructed.

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North Sarah, developed by McCormack Baron Salazar in partnership with the St. Louis Housing Authority, includes a combination of 120 mixed-income townhomes and garden-style apartments. The complex also has 12,000 square feet of commercial, management and community space, which includes a small, locally owned, fresh food grocery store. Phase II is scheduled to be completed in March 2014 and will add an additional 103 units. Vincent R. Bennett, executive vice president and chief operating officer of MBS said, “Sustainability means a lot of things: reducing a building’s impact on the environment is just a piece of this. The sustainable features at North Sarah also include creating healthy living environments for our residents by reducing toxins and ensuring sufficient air flow. The community is walkable and connected to transit, keeping non-drivers like seniors and the disabled from becoming isolated. And, the fresh food grocery will provide healthy living choices that will sustain our residents in the long-term.” In addition to the new housing and commercial space, the development also generated significant economic benefits in the community by targeting construction jobs and contracts to disadvantaged businesses and workers. The total estimated investment of $49 million for the two phases will generate lasting impacts in the City of St. Louis and for the region and State:

approximately $6 million. This represents the sum of taxes on employee compensation, proprietor income, indirect business taxes, including property taxes, household income and corporations. *

∙ The annual total financial impact during the operation phase is $6 million. *

∙ During operations, the project is estimated to create and maintain 65 permanent jobs. *

∙ The annual tax impact generated by the operations phase of the project is approximately $1.03 million. *

Further, the development team has partnered with Urban Strategies, Inc. to engage residents of the community

Vincent R. Bennett is the executive vice president and chief operating officer of McCormack Baron Salazar, the developer for the North Sarah Apartment project. Photo courtesy of MBS.

and help lower- income residents follow viable, upwardly-mobile

career and life paths, by connecting them with health, financial, recreational, educational, employment and entrepreneurial resources and services. “This community is a manifestation of the St. Louis Housing Authority’s mission:

∙ The total financial impact of construction is $70.6 million over 3.5 years. *

to use physical housing development to catalyze holistic community revitalization,” explained St. Louis Housing Authority Executive Director Cheryl Lovell. “Everything in North Sarah, from the environmentally sustainable architecture to the inclusion of flexible live-work spaces to the structure of the human capital services is designed to support and enrich the lives of people from all walks of life, means, and abilities.”

∙ The project is estimated to create a total of 295 construction-related jobs during the 3.5 year construction period plus an additional 153 jobs will be created within supporting industries for a total of 448 jobs. *

∙ The annual tax impact generated by the construction phase of the project is

* Source: IMPLAN Economic Impact Report

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REAL ESTATE

How It Works As a federal program run by individual state housing agencies, the U.S. Treasury allocates about $8 billion annually to the state agencies. These agencies select projects and award tax credits on the acquisition, rehabilitation or new construction of rental housing specifically targeted to lower- income households. The process is very competitive given the overall demand for affordable housing. For instance, the Missouri Housing Development Commission is typically oversubscribed 4-to-1. A developer must apply for these credits and, if selected for an allocation of credits, must raise equity to fund development costs. Developers receive tax credits for the portions of the housing projects that are set aside for low and moderate income level households. For example, if a developer’s project is awarded $100,000 annually in credits, it will receive these credits over the 10-year allocation period for a total of $1,000,000 in tax credits. The developer will monetize these credits by raising equity for a discounted price per credit, say $0.80 for every dollar of credit allocated. This equity subsidy allows for reduced rents to be charged to tenants. There are many strict guidelines to ensure the tax credits go for their intended use. If the project falls out of compliance, the tax credits must be repaid in the form of tax credit recapture. The investors, developers and state housing finance agencies all provide asset management and oversight to ensure the properties are working as intended. In addition, each development is required to have an annual audit performed by an independent CPA.

So how does such an amazing development get built in the North Side, an area of St. Louis that has been desolate and in need of revitalization? A combination of incentives paved the way, starting with a $7.8 million HOPE VI Grant to the North Sarah project and $12.3 million in federal and state LIHTCs. U.S. Bancorp Community Development Corporation, the community investment subsidiary of U.S. Bank, invested for both the Federal and state LIHTCs. Yet, with the collaboration garnered by this project, and ultimately all LIHTC developments, the program and what it creates could be in jeopardy. Unfortunately, people are not well-informed on how the credit works or what it does. corporations get dollar-for-dollar federal income tax credits obtained at a steep discount while the developers reap hefty profits at the sacrifice of taxpayers. But if the public takes a closer look, it will find an effective and efficient financing tool that truly works to revitalize a community and its residents. Background On The Program Created by the tax reform act of 1986, the LIHTC program has arguably been the most successful pairing between the government and private sectors. Ultimately, the private sector, rather than the government, bears the risk and pays most of the costs along with the tenants who rent the affordable housing units. This program has been more successful at creating stable housing for moderate to low income individuals than any other subsidized government program. Since inception, it has produced approximately 2.6 million rental units and creates about 100,000 jobs annually. It’s often misunderstood to be a corporate windfall where financial institutions and large

But taking a step back from the program’s logistics and where the dollars fall, it is

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important to note that at the heart of this program is the impact it has had on families across the country. Ensuring that a child knows where his or her home is from week to week coupled with the rippling effects a stable home has on the child, his or her community and his or her future is truly immeasurable and reaches far beyond the credit dollars the home may have been awarded. America needs job creation and quality affordable housing more than ever. Now is not the time to contemplate eliminating or reducing this powerful financing tool. The affordable housing industry must have a true sense of urgency and it needs to grow from a grass roots effort. It is imperative that the industry work closely with the public, and their state representatives and elected officials to show support for the credit and to ensure it will survive tax reform.

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Bryan Keller, CPA – Saint Louis Partner-In-Charge Real Estate Services Group 314.290.3341 bryan.keller@rubinbrown.com

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LIFE SCIENCES LIFE SCIENCES

Tax Changes & Valuation Issues Unique to the Life Sciences Industry by Steve Hays, CPA & Leigh Ellebrecht

Valuation Issues Unique to Life Sciences Companies Companies in the life sciences industry require valuations for various reasons: transactions (raising investment funds, compensating employees, licensing intellectual property, etc.), tax purposes, financial reporting, or litigation purposes. Due to the innovative nature of the industry, there are many start-up life sciences companies that are focused on research and development but have not yet started generating positive cash flow. Generally

speaking, the earlier the stage of a company, the less useful traditional valuation methods will be. Valuation Overview There are three main approaches to valuing a company:

1. Income approach

2. Market approach

3. Asset approach

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The income approach determines the value of a business based on its expected earnings, or cash flow. With the market approach, the value of a business is determined by comparing the subject company to publicly traded shares of similar companies, or to like businesses which have recently been sold. The market approach can be difficult to apply to life sciences companies, as many of these companies provide innovative solutions for which there are no suitable comparable companies or transactions in the market. In using the asset approach, the value of a business is determined by considering the value of its assets and liabilities. This method is also called the cost approach, as it values a company based on the individual or component costs of its assets, rather than the future cash flow the company is expected to generate. The discounted cash flow method is used when a company’s future income stream is expected to differ from recent or current operating results, which is usually the case with early stage companies. Under the discounted cash flow method, the value of a business is determined by discounting future expected cash flow to present value using a cost of capital. The two inputs driving a discounted cash flow model are the projected cash flow and the discount rate, which is based on the timing and risk of receiving future cash flow. Projected Cash Flow Projected cash flow takes into account the company’s projected revenues, profitability, and required reinvestment. The required reinvestment is the capital that the company must invest to be able to earn the future The two methods used to determine value under the income approach are: 1. Direct capitalization method 2. Discounted cash flow method

cash flow; for example, purchasing new equipment or a building.

Life sciences companies are typically early stage, and are often pre-revenue or pre- profitability. It can be difficult to project future cash flow with any certainty without a track record of historical cash flow on which to base the projections. One solution is to create a decision tree, which uses a probability weighted scenario analysis to value a company. The decision tree on the following page provides an example of a probability weighted valuation. The joint probability is calculated by multiplying prior probabilities. For example, the first joint probability is calculated as 90% x 75% x 20% = 14%. The sum of all joint probabilities is 100%. The “valuations of future cash flow” are calculated in four separate discounted cash flow models (not shown) and then multiplied by their respective joint probabilities to determine the probability weighted value of the company of $217 million.

The three main determinants of the hypothetical company’s cash flow are:

1. Whether or not they successfully complete clinical trials

2. Whether the product receives immediate or delayed FDA approval

3. Whether the product receives high or low market adoption.

The decision tree allows us to consider these various scenarios, which is especially helpful when valuing early stage companies that have not yet started generating positive cash flow. Another benefit of the decision tree is that the valuation can be updated over time as the company reaches certain milestones or as market conditions change.

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