Cutting cybersecurity costs may prove costly for boards and their organizations

Boards of directors can guide cybersecurity programs by demanding transparency and challenging cost-cutting strategies.

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Cutting cybersecurity costs may prove costly for boards and their organizations

VIDEO | April 26, 2023 | Authored by RSM US LLP

In Corporate Board Member’s 20th annual “What Directors Think” study, public company board members said that cybersecurity is their most challenging issue to oversee.

Based on his experience helping companies advance their cybersecurity programs, Matt Franko, principal with RSM US LLP’s risk consulting practice, joined Jamie Tassa, publisher of Corporate Board Member magazine, to share valuable advice about how to improve your oversight efforts.?

Below the video is a transcript of the discussion, edited for clarity and length.

Jamie Tassa: Do you think it’s fair to say that cybersecurity investments are on the chopping block? And if so, what should boards’ argument be to management to consider cutting costs anywhere but cyber?

Matt Franko: I would say statistically we have seen this out in the field as we are working and consulting with clients. It is fair to say that everything is on the chopping block, not just cybersecurity spending. Across the board, organizations are looking for ways to contain cost, and cybersecurity is one of those.

We have seen lots of organizations cutting their spending, and some, are sacrificing some of their protection mechanisms. We have seen a lot of organizations that we have helped—specifically, going through their cybersecurity budgets and finding things that they are double-paying for.

A lot of organizations may have licensing for a tool that provides cybersecurity protections, and they are also paying another provider or looking at another tool to get those same types of protections. We have seen a lot of organizations go through that—where they are looking at their cost-benefit, but making sure that if you are removing a controller, if you are removing a technology or removing a spend, that you are still managing the risk in the same way, but just in a more efficient way.

Tassa: Part of the challenge for boards in an oversight role is not getting too far into the weeds on some of this stuff. What is your advice there? What is the right level of getting in deep enough to be able to know the risks and flag them versus relying on the CISO (chief information security officer) to really be managing it and bringing things to the board on a need-to-know basis?

Franko: I have been lectured numerous times by board members on what the role of a board member is and where and how they should be playing. So, I think it is walking that fine line of not getting too involved and trying to get too deep into the weeds, but also getting the right amount of information.

It is a matter of demanding transparency. Where in the organization does cybersecurity report? A lot of organizations may have a CISO, but the CISO is reporting up through IT or up through the chief financial officer—the individual who is making a lot of the budget cuts and probably has the most riding on cost containment.

Some of the questions you should ask would be around how you determined these changes you’re making. How have you assessed the risk it will present to the organization? How have you worked with the business? In my view of a CISO, your job is to identify risk, communicate risk, provide advice and guidance, but you do not own the risk. That risk lies with the business. So, has the business been involved to say, “We are okay with these changes and willing to accept what they are and how it increases our risk profile”?

Another thing might be to get a third party involved. Has a third party reviewed what we are changing to make sure that we are still effectively managing what we have from our risk profile, and then aligning with industry standards and industry best practices as we make those changes?

Tassa: That’s a great segue to the value of a third party to come in and validate that the company is taking an appropriate cyber approach to the business. If a board were to work with its management team to bring in a third party, what are some of the red flags it should be looking for the third party to uncover? Then, how do they prioritize, particularly in a cost-containment environment?

Franko: We come back to that transparency. So, is that report going directly to the board, using internal audit as the independent sponsor of that assessment? Boards receive third-party reports that are focused on financials all the time, but we don’t see that as much from a cybersecurity standpoint without it going up first through the CISO, , the CIO and so on. So, transparency again becomes key.

Regarding the red flags, they’re going to vary a lot. One thing I would focus on is whether the cybersecurity spend is keeping up with the growth of the organization. As we look to contain costs, whether the economy is struggling or not, there are still organizations that are growing. They’re still going to be making investments in digital transformation because those are, in some cases, going to be cost-cutting measures. But if cybersecurity spend is not keeping up with what the organization is doing, and the cybersecurity activities or the group itself is not heavily engaged in the digital transformation activities, that would be a big red flag.

So a question I would ask here is: Where is cybersecurity involved in our process in terms of going to market or digital transformation? Is it at the end? Is it after we’ve already pushed stuff where it is publicly facing now, or are they involved at the beginning? And what are we doing and how are we considering it?

While cyber incidents are down, now is not the time to take your eye off the ball. We have got to stay strong and firm on effectively implementing and continuing to build good cybersecurity programs.

Tassa: I’d like your quick take on cyber liability insurance—we get a lot of questions around this. Prices are going up. Is it OK not to renew, or is it needed more in some economic, political times than others?

Franko: This is an easy one for me. I would never tell anyone to not have cyber liability insurance. It is like health insurance, D&O (directors and officers) insurance.

It is always a good idea to have it, especially in today’s environment. The average ransomware incident nowadays runs anywhere from high six figures to low seven figures. You want to make sure that you have protections in place. As boards, we understand risk. It’s a matter of, from a risk perspective, what are we mitigating? What are we accepting? Then, anything that is in that gap between, what we are not willing to accept?

I know that premiums have gone up. Insurers have changed the way they are actually providing coverage. So it’s just important that, as an organization, as board members, we’re asking who’s involved in the process.

If the CISO is not heavily involved in the cyber liability insurance process, that should be a red flag that something’s wrong there. If an organization cuts their cyber liability insurance as a cost-cutting or a cost-control measure, it would be good to ask, “Hey, what did the CISO say about this?”

Tassa: Great advice. As we wrap, what is one takeaway? There are a lot more than one, but one good takeaway that any board member listening should bring to his or her next board meeting.

Franko: I would say the most important thing is to understand while cyber incidents are down—and we’ve seen a lot less activity, I would say, in the last year—now is not the time to take your eye off the ball. We have got to stay strong and firm on effectively implementing and continuing to build good cybersecurity programs.

My suggestion to board members is to make sure that you are staying educated on cybersecurity, and you are challenging management on the decisions that they are making around cost containment and how they are still effectively managing the cybersecurity risk associated with those cost-containment decisions.

Let’s Talk!

Call us at (541) 773-6633 (Oregon), (208) 373-7890 (Idaho) or fill out the form below and we’ll contact you to discuss your specific situation.





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This article was written by Matt Franko and originally appeared on Apr 26, 2023.
2022 RSM US LLP. All rights reserved.
https://rsmus.com/insights/services/risk-fraud-cybersecurity/cutting-cybersecurity-cost-prove-costly-for-boards-organizations.html

RSM US Alliance provides its members with access to resources of RSM US LLP. RSM US Alliance member firms are separate and independent businesses and legal entities that are responsible for their own acts and omissions, and each are separate and independent from RSM US LLP. RSM US LLP is the U.S. member firm of RSM International, a global network of independent audit, tax, and consulting firms. Members of RSM US Alliance have access to RSM International resources through RSM US LLP but are not member firms of RSM International. Visit rsmus.com/aboutus for more information regarding RSM US LLP and RSM International. The RSM(tm) brandmark is used under license by RSM US LLP. RSM US Alliance products and services are proprietary to RSM US LLP.

KDP is a proud member of RSM US Alliance, a premier affiliation of independent accounting and consulting firms in the United States. RSM US Alliance provides our firm with access to resources of RSM US LLP, the leading provider of audit, tax and consulting services focused on the middle market. RSM US LLP is a licensed CPA firm and the U.S. member of RSM International, a global network of independent audit, tax and consulting firms with more than 43,000 people in over 120 countries.

Our membership in RSM US Alliance has elevated our capabilities in the marketplace, helping to differentiate our firm from the competition while allowing us to maintain our independence and entrepreneurial culture. We have access to a valuable peer network of like-sized firms as well as a broad range of tools, expertise, and technical resources.

For more information on how KDP LLP can assist you, please call us at:

Oregon Office:
(541) 773-6633

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Banking regulatory tide set to turn in 2023

The Office of the Comptroller of the Currency, Federal Deposit Insurance Corporation and Federal Reserve have zeroed in on numerous regulatory changes for 2023.

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Banking regulatory tide set to turn in 2023

ARTICLE | April 26, 2023 | Authored by RSM US LLP

The Office of the Comptroller of the Currency, Federal Deposit Insurance Corporation and Federal Reserve have zeroed in on numerous regulatory changes for 2023. While some existing rules will see modernization, others will likely see new regulatory guidance altogether. The industry was already anticipating such changes well before the failures of Silicon Valley Bank and Signature Bank in mid-March, and we anticipate those failures will lead to further heightened regulatory scrutiny.

The big themes: Capital, climate, the Community Reinvestment Act, mergers and acquisitions, digital assets, fintech partnerships and, now, liquidity.

Capital

The new vice chair for supervision at the Federal Reserve, Michael Barr, wasted no time pointing to capital at the nation’s largest banks as an immediate action item. In a September speech, Barr noted that the Fed was undertaking a “holistic” review of bank capital requirements. During a separate speech in December, he went a step further when he described the current requirements for capital levels of banks in the United States as “toward the low end of the range described in most of the research literature.”

While the industry waits for clarity on proposed changes to capital requirements—reportedly expected early this year—one area where Barr has moved to assert his supervisory authority is stress testing. On Feb. 9, the Fed released its annual stress test scenarios, the hypothetical strains used to test the nation’s economy. The scenarios included a new component—the “exploratory market shock” for the country’s eight largest banks.

Fed authorities are quick to point out that this shock will not contribute to the capital requirements set by the test; but in our estimation, the outcomes from this year’s stress testing will be analyzed closely by the Fed and likely will provide a meaningful data point as the Fed looks to adjust capital requirements for big banks.

The national banks with assets over $100 billion will be the first to see the impact from any changes to capital requirements. In time, institutions with assets below this threshold may likely see the trickle-down effects.

Climate

All three primary bank regulators spent considerable time in 2022 discussing climate-related financial risk. While the OCC and FDIC have both published principles for climate-related financial risk management targeted initially at large institutions, the Fed has been slower to release climate-related guidance. Fed Vice Chair Barr has indicated that assessment of climate-related financial risk presents a priority that requires further analysis.

The Fed is expected to launch a pilot program in early 2023 to conduct scenario analyses targeting the six largest U.S. banks to better understand the risk posed by climate change. This assessment will be done carefully, as both Barr and Fed Chair Jerome Powell have publicly commented that the Fed is not a climate regulator.

The outcomes from the evaluation of climate on the banking system will likely have broader implications. The Fed, OCC and FDIC are anticipated to work together on supervision efforts, initially focused on climate risk at large banks. To date, the collective commentary from FDIC Chair Martin Gruenberg and Acting OCC Chair Michael Hsu points to climate risk as an issue that will affect all banks; further, it implies an increasing focus on climate at all banks. Gruenberg has indicated in his remarks that smaller and midsize banks should plan wisely to prepare for climate-related risk requirements.

It is worth noting that no regulator has indicated it plans to say which businesses banks should or should not do business with; however, the commentary from the agencies points to greater emphasis on understanding how climate-related financial risks—whether physical or transition-related—will affect the bank and what the bank is doing to monitor these risks to mitigate future losses.

As FDIC Chair Gruenberg said in December, “… while the U.S. government may provide assistance with the costs associated with many severe weather events, financial institutions should not be wholly dependent on this assistance, whether directly or indirectly.”

“While the U.S. government may provide assistance with the costs associated with many severe weather events, financial institutions should not be wholly dependent on this assistance, whether directly or indirectly”

Martin J. Gruenberg, FDIC Chair

Community Reinvestment Act

The often talked-about modernization of the Community Reinvestment Act, known as CRA, will see a final rule released in 2023—possibly as early as the first half of the year—and will likely result in a significant uplift in compliance for all institutions.

With more than 650 comments submitted on the joint proposal released in May 2022, the list of concerns from the industry is long. Some of the more prominent ones address the complexity of evaluation methods, the timelines for implementation (is the proposed 12 months enough?), how retail lending is defined and how the agencies will use significantly more granular information submitted by banks for compliance.

The final rule will shed light on those concerns and provide greater clarity around the asset thresholds that dictate the overall level of compliance required for banks of varying sizes. However, the fact remains that modernization will result in a substantial reform to the 45-year-old law originally put in place for a nondigital banking landscape.

Once a final rule is published, the impact on compliance teams, bank technology used in the compliance function and the overall effort to report data will result in considerable resource strains.

Further, given the scope of a proposed rule on providing insight into how banks serve low- to moderate-income communities, CRA compliance will be a bigger factor in merger reviews going forward.

Mergers and acquisitions

The current macroeconomic and regulatory environment has created a one-two punch to the gut of banking mergers and acquisitions. January 2023 saw only six deals announced, amounting to the slowest January in 14 years, according to S&P Global Market Intelligence data.

Yet even when the economy moves beyond current macroeconomic headwinds, the crux of the matter remains: Bank regulators are already looking more closely at deals, even without a change to existing regulation, a trend directly attributable to President Biden’s July 2021 Executive Order on Promoting Competition in the American Economy.

The most recent data from the Fed shows the processing time to review M&A proposals has increased. For M&A proposals that did not receive adverse public comments, average processing time in the first half of 2022 was 65 days, up from 62 days in 2021 and 53 days in 2018. More onerous were proposals that gleaned adverse public feedback; the average processing time in the same period climbed to 197 days, compared to 186 days in 2021 and 113 days in 2018.

And it wasn’t just the largest banks that saw the length of review increase. Community banking organizations with $1 billion to $10 billion in assets also saw their approval times increase. Processing took an average of 90 days in the first half of 2022, compared to 51 days a year earlier.

The regulatory leaders at the primary banking agencies are all on record characterizing the current measures for reviewing bank mergers as outdated. Yet clear commentary on how the reviews should be handled has not been presented.

Speculation and commentary on how merger reform may take place continues to build. During the OCC’s bank merger symposium on Feb. 10, OCC Senior Deputy Comptroller Benjamin McDonough pointed to his agency’s contention that the merger review process deserves renewed consideration. He said the Herfindahl-Hirschman Index, a commonly accepted measure of market concentration, is a poor proxy for measuring bank market share.

Digital assets

Since late 2022, the landscape for digital assets has been defined by volatility. Uncertainty, combined with public commentary from banking regulators, culminated in a joint statement in January by the Federal Reserve, the FDIC and the OCC on crypto-asset risks to banking organizations. Banking business models with a significant concentration of offerings to digital asset companies would be “inconsistent with safe and sound banking practices,” their joint statement said.

Without a defined framework that includes offering digital assets products, both the regulators and banks themselves may struggle to figure out what constitutes safe and sound banking practices. This has left some digital asset firms without banking partners, while others have landed a banking relationship with banks historically not serving this space.

With increased concern related to digital assets, banks are certain to see greater scrutiny, especially in the areas of anti-money laundering, enhanced due diligence around onboarding new customers and overall liquidity management of digital asset customers.

Fintech partnerships

The increasing number of partnerships between banks and consumer-focused fintech organizations through banking as a service is also drawing increased scrutiny from the OCC and FDIC.

In a September 2022 speech, Acting OCC Comptroller Hsu stated: “The growth of the fintech industry, of banking-as-a-service (BaaS), and of big tech forays into payments and lending is changing banking, and its risk profile, in profound ways.” Core to the concern is the blurring line between banking and fintech, he noted, adding: “(When) do customers go from being the client to becoming the product and how are consumer protections maintained?” 

A large portion of BaaS partnerships exist at banks that have under $10 billion in assets, with nearly one-fifth at banks with total assets under $1 billion. The risk to institutions of this size rapidly expanding into such partnership focuses on four primary areas—people, policy, process and technology.

Each of these four areas deserves a detailed and thorough discussion. But simply put, without adequate technology to handle the volume of transaction and account activity, along with commensurate processes, detailed policies for monitoring compliance, and knowledgeable people to support these complex arrangements, blind spots will surface. These could lead to regulatory noncompliance or worse, including financial penalties and losses.

In 2022, the OCC stepped up its regulatory review of fintech partnerships and even took formal action against one institution for failures in its monitoring of fintech partners. The primary focus of both the OCC and the FDIC includes monitoring of programs, staffing levels, and compliance with the Bank Secrecy Act, the Anti-Money Laundering Act and the regulations of the Office of Foreign Assets Control.

Liquidity

The failure of Silicon Valley Bank and other recent turmoil in the sector has underscored the need for financial institutions to evaluate the need to update existing liquidity stress indicators, metrics, guidelines, and limits. Leadership teams may also consider monitoring the utilization of borrowers’ unfunded lines of credit and determining the corresponding impact on the institution’s liquidity position, as well as analyzing borrowers’ credit quality as access to capital tightens.

During hearings on Capitol Hill in late March, Federal Reserve Vice Chair Michael Barr indicated changes that could be coming for mid-tier banks with assets above $100 billion. In addition to capital rules that were already under consideration, the Fed is now weighing liquidity requirements.

Additionally, in a March 30 briefing, President Biden called on regulators, not legislators, to reinstate rules that would toughen oversight of banks between $100 billion and $250 billion in assets. Key points of focus in the president’s remarks included liquidity requirements and enhanced liquidity stress testing.

The omission of congressional action in the president’s briefing keeps the regulators, rather than Congress, in the driver’s seat. Simply put, this means changes will be felt sooner under existing regulatory authorities as any action from Congress would be difficult given the division of power between the House and Senate.

The takeaway

With less than two years left in President Biden’s first term, we expect 2023 to be a do-or-die year for the financial regulatory agencies ahead of the next presidential election cycle. The favorable regulatory environment created by the prior administration and record government stimulus injected into the economy are now in the rearview mirror, and regulatory refocus has come to light. Appropriate monitoring of these themes will be critical for banking institutions over the near- to moderate-term.

Let’s Talk!

Call us at (541) 773-6633 (Oregon), (208) 373-7890 (Idaho) or fill out the form below and we’ll contact you to discuss your specific situation.





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This article was written by Brandon Koeser and originally appeared on Apr 26, 2023.
2022 RSM US LLP. All rights reserved.
https://rsmus.com/insights/industries/financial-institutions/banking-regulatory-tide-set-to-turn-in-2023.html

RSM US Alliance provides its members with access to resources of RSM US LLP. RSM US Alliance member firms are separate and independent businesses and legal entities that are responsible for their own acts and omissions, and each are separate and independent from RSM US LLP. RSM US LLP is the U.S. member firm of RSM International, a global network of independent audit, tax, and consulting firms. Members of RSM US Alliance have access to RSM International resources through RSM US LLP but are not member firms of RSM International. Visit rsmus.com/aboutus for more information regarding RSM US LLP and RSM International. The RSM(tm) brandmark is used under license by RSM US LLP. RSM US Alliance products and services are proprietary to RSM US LLP.

KDP is a proud member of RSM US Alliance, a premier affiliation of independent accounting and consulting firms in the United States. RSM US Alliance provides our firm with access to resources of RSM US LLP, the leading provider of audit, tax and consulting services focused on the middle market. RSM US LLP is a licensed CPA firm and the U.S. member of RSM International, a global network of independent audit, tax and consulting firms with more than 43,000 people in over 120 countries.

Our membership in RSM US Alliance has elevated our capabilities in the marketplace, helping to differentiate our firm from the competition while allowing us to maintain our independence and entrepreneurial culture. We have access to a valuable peer network of like-sized firms as well as a broad range of tools, expertise, and technical resources.

For more information on how KDP LLP can assist you, please call us at:

Oregon Office:
(541) 773-6633

Idaho Office:
(208) 373-7890

FAQ: Capitalization and amortization of R&D costs under new section 174 rules

See how the new required tax treatment of R&D costs under section 174 affects federal, state, and international taxes, as well as software development.

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FAQ: Capitalization and amortization of R&D costs under new section 174 rules

ARTICLE | April 25, 2023 | Authored by RSM US LLP

The required capitalization and amortization of research and development costs under the new section 174 rules are proving problematic, costly, and confusing for many middle market companies—especially those in industries and sectors heavily engaged in R&D and software development, such as life sciences and technology.

To help you better understand how the new rules affect your business, see below for the answers to frequently asked questions about the changes to section 174 and their ramifications for a wide range of tax and accounting issues.

Basics of the new tax treatment of R&D expenses under section 174

Q: What changed, exactly, in the required tax treatment of R&D expenses?

A: For tax years beginning after Dec. 31, 2021, taxpayers must capitalize and amortize all R&D expenditures paid or incurred in connection with their trade or business. The straight-line recovery periods are five years and 15 years for domestic and foreign-incurred R&D, respectively.

Previously, taxpayers could immediately deduct R&D expenses from their taxable income. The unfavorable change was enacted as part of theTax Cuts and Jobs Act of 2017. At the time TCJA was enacted, many hoped that Congress would revisit this change to the tax treatment of R&D expenses before it took effect. However, without legislation to reinstate immediate deductibility, the requirement to capitalize and amortize R&D expenses is the law.

It’s worth noting that the TCJA change to section 174 did not affect the section 41 rules for claiming an R&D tax credit. The determination of qualified research expenditures has not changed.


Q: Why is this new requirement so significant and difficult to implement?

A: The difficulty stems from the need to identify R&D activities conducted and allocate relevant costs. A business cannot tie this to a specific cost on its general ledger. In addition, taxpayers now must layer on software development considerations that historically may not have been viewed as an R&D activity.

Before this change, because deducting expenses under section 174 provided favorable treatment to costs that the business might otherwise capitalize, businesses that did not look for qualifying costs were not creating additional tax exposure. Now, they have to find those costs because they are required to capitalize and amortize them over the appropriate period. This process puts more of a burden on taxpayers.

Another set of major challenges results from how interconnected section 174 is with other tax issues. The new requirement cannot be addressed in a vacuum; taxpayers likely will experience ancillary effects.

Before this change, businesses wanted to pursue qualifying R&D activities because they could deduct their costs and get out-of-code sections that otherwise would require capitalization of those costs. Other rules were written with the understanding that section 174 allowed for immediate deductibility. Now that section 174 is unfavorable, it’s difficult to reconcile those other rules because the intent is skewed from what it was.


Q: What industries are most affected by this change?

A: When many people think of R&D, they think of experts wearing goggles and white coats in a laboratory. That isn’t wrong, of course, but R&D activities covered by section 174 reach beyond obviously affected industries such as life sciences and technology. They likely affect taxpayers across all industries, including, for example, manufacturing, government contracting, and some financial institutions.

Beyond those, think about software development. There are professional services and law firms that develop internal-use software. There are architects, engineers, and various types of manufacturers that are just working to improve a product.

In other words, this affects every industry.


Q: Does my business have to comply with the change to section 174?

A: Yes. Section 174 is not elective and will apply to any taxpayer engaged in R&D activities.


Q: Can my business get out of the new section 174 requirement if it chooses not to claim an R&D tax credit under section 41?

A: No, claiming credits under section 41 is irrelevant in determining whether an expenditure is an R&D expense subject to the new requirement to capitalize and amortize them.


Q: Do the new section 174 rules affect other sections of the tax code?

A: Yes, they affect several other code sections. Taxpayers will need to understand how the new section 174 rules may affect certain calculations under other code sections. Given these ancillary effects, taxpayers may need to prioritize the new section 174 requirement when preparing their taxes.


Q: Is capitalizing and amortizing R&D expenses a method of accounting?

A: Yes. The change from deducting to capitalizing and amortizing these costs is a change in method of accounting that will generally follow normal accounting method change procedures (e.g., filing a Form 3115); however, for the first required year of capitalization, a taxpayer can include a white paper statement with their tax return in lieu of filing a Form 3115.


Q: Are there any silver linings in the change to section 174?

A: Yes. The change from deducting to capitalizing and amortizing these costs is a change in method of accounting that will generally follow normal accounting method change procedures (e.g., filing a Form 3115); however, for the first required year of capitalization, a taxpayer can include a white paper statement with their tax return in lieu of filing a Form 3115.

Identification and treatment of R&D expenses

Q: How do I determine what constitutes an R&D expense?

A: R&D expenses are not specific types of costs. Instead, they are determined by the activity a taxpayer undertakes. R&D expenses are present if a taxpayer develops a new or improved product or service or develops software.

Taxpayers developing a new or improved product or service must be uncertain whether the intended functionality or capability can be developed or about the appropriate design needed to achieve the intended functionality or capability. In this circumstance, the taxpayer undergoes a process of experimentation that is technological in nature to resolve the uncertainty.

Typical project expenditures subject to capitalization include:

  • Researchers’ wages, including nontaxable benefits
  • Contract research expenditures (100% versus 65%)
  • Direct research supervisor wages for researchers
  • Cost of supplies
  • Overhead expenses, including rent, utilities, and depreciation
  • Depreciation on equipment directly used or allocated to an R&D activity
  • Costs attributable to a pilot model
  • Expenditures for software development

Q: How is it determined what activities give rise to R&D expenses?

A: In the absence of specific guidance, taxpayers must use a reasonable approach to interpreting the law.

The law provides the instruction of Congress to defer the recovery of R&D expenses over five or 15 years. There is nothing to suggest that Congress intended to change the definition of R&D expenses aside from including software development costs. Because of this, until the IRS issues further guidance, it is reasonable to continue to rely on guidance under section 174 as it existed before amendments by the TCJA.


Q: How do I determine if my business has R&D expenses?

A: While not every business will have R&D expenses, many do, especially if it produces goods or incurs expenses related to software development (i.e., websites, mobile applications, enterprise resource planning systems, etc.). Generally, businesses with engineering departments, R&D departments, or those that report R&D expenses in their financial statements have significant R&D expenses.


Q: How do costs covered under section 174 differ from those that qualify for the R&D tax credit?

A: Section 174 covers a broader range of activities and costs than those that qualify for the R&D tax credit under section 41. Generally, costs that qualify for the R&D credit will also be treated as section 174 costs; however, the inverse is not true.

For example, wages that qualify for the R&D tax credit are limited to Box 1 wages (or self-employment earnings in the case of a sole proprietorship). But section 174 qualifying wages include additional wage amounts, such as nontaxable benefits and retirement contributions. There is a so-called “substantially all” rule for the R&D credit where taxpayers may claim 100% of Box 1 wages for employees that spend 80% or more of their time performing qualifying activities—this does not exist for section 174.

When it comes to payments made to third parties to perform contract research, only 65% of eligible contract research expenses are included toward the R&D credit, whereas 100% may be eligible for inclusion as a section 174 cost. Additionally, section 174 costs include allocable overhead costs, such as rent and utilities, as well as the depreciation of equipment used in the R&D process, and patent legal expenses that aren’t included in qualifying R&D tax credit costs.

It’s important to note that all computer software development costs are now considered section 174 costs. For R&D credit purposes, there is a higher threshold for software development initiatives to be eligible for the credit in the case of software developed by the taxpayer for internal use. There is no such threshold for section 174, so taxpayers may notice a much higher section 174 cost compared to what is claimed for R&D credit purposes for software development initiatives.


Q: If my business has never claimed an R&D tax credit, might we still have R&D expenses?

A: It’s possible. Some taxpayers forgo taking the R&D credit for various business reasons but still have R&D expenses. Also, expenditures paid or incurred in software development are considered R&D expenses and may not be captured in an R&D credit study.


Q: What method should my business use to allocate our indirect costs?

A: Generally and without IRS guidance, there is no right or wrong way, although costs should be allocated based on a reasonable methodology. Many practitioners deem reasonable methodologies to include allocations based on employee headcount or square footage (similar to section 263A methodologies). Alternatives that best align with a business’s facts and circumstances can also be used.


Q: My company performs contract research for other taxpayers on a cost-plus basis. How will those costs be treated?

A: In the absence of specific guidance addressing this issue, RSM’s view is that companies that provide contract research services and do not retain risks or rights to the underlying research are service providers and would have section 162 expenses, not section 174 expenses.

Any agreements should be reviewed to determine whether the risks and rights retained by each party give rise to section 174 expenses.


Q: My business engages third parties to perform research. Does that constitute section 174 expenses?

A: In the absence of specific guidance addressing this issue, RSM’s view is that a company that engages a third party to perform research on the company’s behalf has section 174 expenses if the company maintains the risks and rights to the underlying research.

Any agreements should be reviewed to determine whether the risks and rights retained by each party give rise to section 174 expenses.


Q: My company reimburses the costs incurred by a subsidiary/parent for research expenses. Do both entities have section 174 expenses?

A: With cost reimbursements, the taxpayer receiving reimbursement may not have an expense to capitalize. A rights/risk analysis of the work performed is likely required first to see which party should be treated as incurring section 174 expenses.


Q: Can my business use its generally accepted accounting principles (GAAP) or ASC 730 numbers as a proxy for its R&D expenses?

A: No, not without a book safe harbor provided by the IRS or Treasury Department. In addition, the GAAP research numbers may not include software development costs. However, knowing the total amount of research costs capitalized for book purposes may provide a starting point for determining the scope of activities to include in the tax R&D expense analysis.


Q: Are taxpayers required to capitalize section 174 expenses for book purposes also?

A: No, the taxpayer’s financial statement treatment will still be governed by the appropriate financial accounting standard (GAAP, etc.). Section 174 applies to tax treatment only.


Q: What if my business abandons or scraps a section 174 project before related costs have been fully amortized?

A: Regardless of the abandonment of the underlying property, capitalized R&D expenses costs will continue to be amortized over the respective 5- or 15-year period.

Software development

Q: How does the inclusion of software development in section 174 differ from prior years?

A: Software development is now statutorily defined in section 174 as an R&D expenditure.

Many taxpayers find that they have R&D activities buried throughout their trial balance, or they did not look at software development because they are not software developers, per se, but do, in fact, have software development activities. Those activities may include software development and would be R&D now. For example, a taxpayer may be a grocery store that develops a mobile app, a website functionality to enable sales, or internal accounting systems for delivering goods or services.


Q: Now that software development is an R&D activity, is there a bright-line definition of what constitutes software development?

A: Unfortunately, there is no bright-line definition of software development. Through published guidance and case law, software development costs generally consist of costs incurred to write additional machine-readable code that allows a software program to function in a desired way.

If a third party is used to write the additional code, a benefits and burdens analysis should be performed to determine whether the costs are development costs or acquisition costs.


Q: What areas of software development may not be deemed section 174 costs?

A: It is a gray area, but acquiring someone else’s R&D or software, lease, or software license is likely not covered under section 174. There may be positions to take the configuration of existing functionality within a software package as excluded from section 174.


Q: What determines if software is in an R&D state or an implementation stage?

A: The underlying activity is the determining factor. It is very common to segregate or bifurcate the phases of implementation, and taxpayers may find certain development or customization activities are taking place throughout. Activities such as configuring existing functionality may not give rise to R& D.


Q: Are software subscriptions and implementation service fees for new ERP software and services or other business and technology applications still subject to Rev. Proc. 2000-50?

A: Rev. Proc. 2000-50 will still govern the treatment of acquired, leased, or licensed software (effectively recovered over the license term in a SaaS environment). However, it is common to see further development or customization activities above the minimum license—these costs may be subject to section 174 as software development expenditures.


Q: Are the majority of costs for software as a service (SaaS) technology companies now required to be capitalized?

A: Generally, on the development side of the business, yes. Ongoing maintenance and customer support are generally still deductible as incurred.

State and local tax

Q: How does state conformity affect section 174?

A: Generally, state conformity to the federal tax code must be reviewed state-by-state. While some states automatically conform to changes to the code for state income tax purposes (called rolling conformity states), many others have fixed-date conformity or only conform to specifically enumerated provisions.

Accordingly, it is critical to understand whether the state conforms to the TCJA changes made to section 174. Most, but not all, states have updated their conformity dates or specific conformity provisions to incorporate changes made by TCJA or otherwise conform to the provisions through rolling conformity to the code.


Q: Have any states decoupled from section 174?

A: As an example, at least one state, Tennessee, has enacted specific legislation to decouple from the federal capitalization requirements under section 174 and allow state-level current expensing. Other states may propose or enact legislation to decouple from the federal capitalization rules during the 2023 or 2024 legislative sessions.


Q: Is the state treatment identical for pass-through entities as for corporations?

A: Some states have differing conformity rules for corporations and pass-through entities, creating a disconnect between proper state treatment of expenses under section 174 for differing entity types. Pass-through entities should consider these differences, especially because conformity to section 174 is often addressed in a corporate context.


Q: Are there any concerns about state-level R&D credit computations?

A: Some state R&D computations reference federal section 174 rather than section 41. As taxpayers analyze section 174 expenses for federal purposes, it may be beneficial to reclassify some costs as deductible under a different federal code section, where possible, to preserve current deductibility for federal purposes. Such a reclassification could have a negative impact on the state R&D credit for jurisdictions that reference section 174 as the basis for the state-level credit computation. This is a nuanced and state-specific analysis.


Q: How could potential federal changes impact the states?

A: The timing of federal legislation is a key factor for fixed-date or selective conformity states. With most state legislatures out of session by the beginning of summer, there is a distinct possibility that some states will not be able to respond to federal legislation timely. Changes to federal provisions, effective in 2023 or earlier, may not be conformed to by many states until 2024 state sessions or later.

International tax

Q: Does the new requirement under section 174 apply to my business’s foreign operations?

A: Yes, with a key difference: section 174 costs incurred in R&D activities that take place outside of the United States must be amortized over 15 years rather than five. This difference in the law is meant to provide a clear incentive to perform such activities in the United States. In practice, this may or may not tip the scale against valuable foreign-country incentives, but it will certainly take a bite out of those cash flows.


Q: Does this affect my business’s foreign tax, U.S. tax, or both?

A: These capitalization rules apply to section 174 expenses incurred in any foreign operations whenever that income is being computed or reported on a U.S. tax basis. That is, nothing is changing for local country tax or statutory accounting purposes. These rules must be applied where your foreign activities meet your U.S. tax reporting and taxable income. For example, computation of global intangible low-taxed income (GILTI), Subpart F, foreign tax credits, foreign-derived intangible income (FDII), and base erosion and anti-abuse tax (BEAT); reporting on Forms 5471, 8858, 1118, 8991, etc.


Q: How will this affect my organization’s U.S. tax liability on foreign operations?

A: It will always depend on the specific facts and circumstances, but in general, we expect the following:

  • If a taxpayer is subject to GILTI: The capitalization of R&D expenses at the foreign subsidiary level will increase GILTI income on the U.S. parent’s return. It may also alter the applicability of the GILTI high-tax exception election (HTE), bringing other foreign subsidiary profits into the GILTI inclusion that may have been excludable in prior years. Because GILTI is accounted for as a period cost for ASC 740 purposes by most taxpayers, this may increase the taxpayer’s effective tax rate.

  • Subpart F income would be similarly affected.

  • R&D expenses incurred by foreign branches in the local country would be subject to a 15-year amortization through the U.S. parent’s return, increasing U.S. taxable income from the branch operation without a corresponding increase to available foreign tax credits in the branch basket.


Q: Is there any good news on the international front?

A: The capitalization of section 174 costs could favorably affect taxpayers in the following areas:

  • Foreign tax credit limitation: Special rules regarding the apportionment of R&D expenses generally exert downward pressure on taxpayers’ ability to claim foreign tax credits. The limitation on R&D deductions to a relatively small amount of amortization may have the side effect of releasing pressure on foreign tax credit limitations and increasing credit claims.

  • FDII: Where section 174 capitalization increases U.S. taxable income, this may serve to increase the FDII deduction proportionally. This is a favorable, permanent book-tax difference, and therefore may result in a reduction to a taxpayer’s effective tax rate.

  • BEAT: In general, increased regular taxable income will make a BEAT liability less likely. Further, taxpayers who make base erosion payments for R&D will see reduced base erosion tax benefits in the near term as deductions for those expenses are limited and deferred through capitalization and amortization. This may help some taxpayers pass the 3% test for BEAT applicability or, barring that, reduce the BEAT tax base.

Legislative processes, administrative guidance, and advocacy

Q: What happened to congressional action regarding required capitalization?

A: While there is broad bipartisan support to repeal or defer the required capitalization of R&D expenses, Congress did not come to an agreement to do so before the 117th Congress adjourned at the end of 2022.

A bill to reinstate full and immediate deductibility was introduced in the Senate on March 16, 2023, and is co-sponsored by seven Republicans, five Democrats, and one independent. However, despite that example of bipartisan support, RSM’s tax policy team believes it is very unlikely that the 118th Congress will make any changes to section 174 because the two parties have different political priorities.

Further, retroactivity in future legislation is uncertain. Ultimately, taxpayers must proceed with the current state of the law and capitalize and amortize their R&D expenses.


Q: As capitalization is the law, what guidance have the IRS and Treasury issued?

A: The IRS released a revenue procedure with the procedures and terms and conditions for a taxpayer to change its method of accounting for R&D expenses. Substantive guidance has not yet been issued as of late March 2023, and we do not expect additional guidance in this area until late spring or summer of 2023 at the earliest.


Q: What can my organization do to advocate reinstating the immediate deductibility of R&D expenses?

A: Taxpayers eager to share their thoughts directly with policymakers can communicate with their local congressional representatives. RSM’s tax policy team members have found that congressional staffers appreciate hearing from taxpayers and businesses to better understand the real-world ramifications of their actions or lack thereof.

Let’s Talk!

Call us at (541) 773-6633 (Oregon), (208) 373-7890 (Idaho) or fill out the form below and we’ll contact you to discuss your specific situation.





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This article was written by RSM US LLP and originally appeared on Apr 25, 2023.
2022 RSM US LLP. All rights reserved.
https://rsmus.com/insights/services/business-tax/faq-capitalization-and-amortization-of-r-d-costs-under-new-section-174-rules.html

The information contained herein is general in nature and based on authorities that are subject to change. RSM US LLP guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. RSM US LLP assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein. This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer.

RSM US Alliance provides its members with access to resources of RSM US LLP. RSM US Alliance member firms are separate and independent businesses and legal entities that are responsible for their own acts and omissions, and each are separate and independent from RSM US LLP. RSM US LLP is the U.S. member firm of RSM International, a global network of independent audit, tax, and consulting firms. Members of RSM US Alliance have access to RSM International resources through RSM US LLP but are not member firms of RSM International. Visit rsmus.com/aboutus for more information regarding RSM US LLP and RSM International. The RSM(tm) brandmark is used under license by RSM US LLP. RSM US Alliance products and services are proprietary to RSM US LLP.

KDP is a proud member of RSM US Alliance, a premier affiliation of independent accounting and consulting firms in the United States. RSM US Alliance provides our firm with access to resources of RSM US LLP, the leading provider of audit, tax and consulting services focused on the middle market. RSM US LLP is a licensed CPA firm and the U.S. member of RSM International, a global network of independent audit, tax and consulting firms with more than 43,000 people in over 120 countries.

Our membership in RSM US Alliance has elevated our capabilities in the marketplace, helping to differentiate our firm from the competition while allowing us to maintain our independence and entrepreneurial culture. We have access to a valuable peer network of like-sized firms as well as a broad range of tools, expertise, and technical resources.

For more information on how KDP LLP can assist you, please call us at:

Oregon Office:
(541) 773-6633

Idaho Office:
(208) 373-7890

The new labor market reality: How controlled growth can drive success

Successful professional services firms are taking a controlled growth approach to manage a dynamic labor market.

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The new labor market reality: How controlled growth can drive success

ARTICLE | April 25, 2023 | Authored by RSM US LLP

Sometimes, it is helpful to take a step back.

Professional services companies often find that to remain nimble, they need to control the growth of their workforce. But this does not have to be a negative experience. In fact, controlled growth can be accomplished even while maintaining a high-performing workforce. The key is to eliminate inefficiencies while bringing out the best in employees.

Stay ahead of the cycle

For many professional services companies, the ups and downs of the economy dictate their goals, their processes, and even the size of their workforce. Successful firms are proactive as they face economic headwinds, reducing the chance that they will have to adjust their workforce abruptly.

To be prepared, leaders must have clear insight into the external factors—the labor market, the economic forecast, and more—that can have a direct impact on their organization. Companies should identify what skills and capabilities will be needed within their firm, based on realistic predictions.

An understanding of both internal and external factors will help companies avoid unpleasant surprises in the future. And in the present, it can help organizations avoid overhiring, lessening the odds that staff will need to be scaled back.

Of course, companies must be brutally honest about their needs and capabilities.

Leaders must answer key questions, such as:

  • How well is the firm operating?
  • How efficient are the different lines of business?
  • How can the stress and workload of employees be eased?
  • What processes are causing inefficiencies in day-to-day operations?
  • Can those inefficiencies be solved by creating new policies that reduce red tape?
  • What is the forecast for each workstream?
  • Who is overworked?
  • Can we outsource or automate key business functions?
  • Who is sitting on the bench for extended periods?

Organizations must gather accurate information on their resources and how they are utilized. And once they have this data, companies must measure progress and results to ensure that their strategies are working and driving value for the organization. This means tracking metrics such as employee satisfaction, retention rates, and productivity levels. The resulting feedback loop can help firms refine and adjust their approach to continually optimize employee performance. Firms can also leverage tools like professional services automation to automate processes, produce real-time project health updates, and refine margin reporting and forecasting to support informed decision-making.

Take care of your talent

Professional services companies may not always like what their metrics tell them. But even if performance indicators are lagging, leaders should not view scaling back talent as the only option to course-correct.

Instead, organizations should address the more likely sources of inefficiency: their processes or systems. Analyzing employee productivity is important, but firms should also examine the efficiency of their technology. Is the company leveraging the right technology stack for its needs? Are systems and applications up to date and customized for the firm’s unique niche?

Often, employees are not able to do their best work because they spend too much time struggling with antiquated systems or glitchy software. Investing in technology can free up employees to focus on high-value tasks that a computer is less likely to handle.

Artificial intelligence is indeed changing the way professional services firms operate. In some cases, controlled growth may mean reducing staff in favor of AI solutions. However, technology is far more likely to assist people than it is to replace them.

Collaboration tools make it easier for teams to communicate effectively and stay on task, regardless of their location. Automated systems streamline processes and make the organization more efficient.

In such cases, employees spend less time on tedious, robotic activities and more time innovating and developing solutions with their colleagues.

Another way to improve productivity is to outsource nonessential functions. As with AI solutions, the goal is not to replace staff members.

For the most part, outsourcing to a third party allows in-house staff members to elevate to a higher skill set. Employees can focus on core functions rather than have their time swallowed up with administrative tasks.

If a company has embraced these solutions but still needs to adjust growth, there are innovative solutions. Offering sabbaticals or changing full-time employees to part-time status may allow staff members to stay with the firm. Also, moving employees into different career paths could preserve their institutional knowledge and help staff members thrive through challenging times.

In this way, controlled growth can benefit the company without penalizing the employees.

Keep it all in balance

Professional services firms that effectively control their workforce can position their company for the next stage of growth. To do so, companies need to be honest about how their organization is functioning, and then use accurate data to guide their decisions.

Additionally, investing in the right technology and embracing outsourcing can help support dynamic teams. By ensuring that staff members focus on top-level tasks, businesses can create an agile work culture in which employees develop their skills without becoming overwhelmed. This ultimately provides teams with greater autonomy and capacity to problem-solve quickly and more effectively—all of which lead to increased productivity, greater employee satisfaction, and a successful firm.

Let’s Talk!

Call us at (541) 773-6633 (Oregon), (208) 373-7890 (Idaho) or fill out the form below and we’ll contact you to discuss your specific situation.





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This article was written by Michael Gerlach, Sonya King and originally appeared on Apr 25, 2023.
2022 RSM US LLP. All rights reserved.
https://rsmus.com/insights/industries/professional-services/the-new-labor-market-reality-how-controlled-growth-can-drive-success.html

RSM US Alliance provides its members with access to resources of RSM US LLP. RSM US Alliance member firms are separate and independent businesses and legal entities that are responsible for their own acts and omissions, and each are separate and independent from RSM US LLP. RSM US LLP is the U.S. member firm of RSM International, a global network of independent audit, tax, and consulting firms. Members of RSM US Alliance have access to RSM International resources through RSM US LLP but are not member firms of RSM International. Visit rsmus.com/aboutus for more information regarding RSM US LLP and RSM International. The RSM(tm) brandmark is used under license by RSM US LLP. RSM US Alliance products and services are proprietary to RSM US LLP.

KDP is a proud member of RSM US Alliance, a premier affiliation of independent accounting and consulting firms in the United States. RSM US Alliance provides our firm with access to resources of RSM US LLP, the leading provider of audit, tax and consulting services focused on the middle market. RSM US LLP is a licensed CPA firm and the U.S. member of RSM International, a global network of independent audit, tax and consulting firms with more than 43,000 people in over 120 countries.

Our membership in RSM US Alliance has elevated our capabilities in the marketplace, helping to differentiate our firm from the competition while allowing us to maintain our independence and entrepreneurial culture. We have access to a valuable peer network of like-sized firms as well as a broad range of tools, expertise, and technical resources.

For more information on how KDP LLP can assist you, please call us at:

Oregon Office:
(541) 773-6633

Idaho Office:
(208) 373-7890

M&A considerations resulting from the new required tax treatment of R&D costs

New requirements to capitalize and amortize R&D costs are affecting M&A buyers by introducing costs and tax liabilities.

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M&A considerations resulting from the new required tax treatment of R&D costs

ARTICLE | April 24, 2023 | Authored by RSM US LLP

An unfavorable change in the required tax treatment of research and development expenditures is affecting mergers and acquisitions by introducing buyers to new potential costs and tax liabilities via their targets. 

The issues are particularly relevant in industries and sectors characterized by R&D initiatives and software development—including life sciences, technology and manufacturing.

Regardless of how a transaction is structured, due diligence and tax modeling can help buyers understand the ramifications of this tax law change and avoid costly surprises.

Section 174: New requirements for tax treatment of R&D expenses

New rules under section 174 require taxpayers to capitalize and amortize specified research expenditures instead of immediately deducting them from taxable income. This change was enacted as part of the Tax Cuts and Jobs Act of 2017 and became effective for tax years beginning after Dec. 31, 2021.

The costs attributable to domestic research now must be amortized over five years, while costs attributable to non-U.S. research must be amortized over 15. Significantly, capitalizable costs include software and development expenditures.

At the time TCJA was enacted, many expected—and hoped—that Congress would act to reinstate the immediate expensing of R&D expenditures under prior law before the effective date of the change. However, despite strong bipartisan support, proposed bills to revert to prior law, and multiple attempts to include a measure in broader legislative vehicles enacted into law during the 117th Congress, the capitalization requirement indeed became effective at the beginning of 2022. As a result, taxpayers are having to come to terms with the new rules as they calculate ASC 740 tax provisions, make tax payments and plan for their cash expenditures.

In the context of an M&A transaction, investors and their tax advisors should consider the impact of required capitalization of R&D and software development expenditures. Regardless of whether a deal is structured as the acquisition of stock or taxable assets, buyers should be mindful of key considerations for tax diligence, purchase agreement negotiation and cash tax projections in operating models.

Stock deals

In a transaction structured as the acquisition of stock in a C corporation, a buyer will typically inherit the federal and state income tax liabilities of the target through its ownership of the corporation. In addition, the accounting methods utilized in the calculation of taxable income generally remain in place and do not change without an affirmative election of new accounting methods.

When performing tax due diligence, a buyer and their advisor should seek to understand the following with respect to the tax treatment of R&D expenditures under section 174:

  • What activities of the target may give rise to costs requiring capitalization?
  • What has the target done to identify, quantify and document capitalizable costs?
  • Has the target followed proper procedures around accounting method changes, if applicable?
  • How does the capitalization of costs affect the target’s overall tax posture?
  • Has the target made the appropriate tax payments after taking into account the new rules?

In many instances, a target corporation may have incurred net operating losses in tax years before 2022, and therefore may not be expecting to pay tax even if the new section 174 requirements cause them to have positive taxable income before applying an NOL. Even when a target has significant NOLs, this position should be scrutinized for reasons including:

  • Utilization of NOLs and other tax attributes can be limited by section 382
  • Utilization of NOLs incurred in tax years beginning after Dec. 31, 2017, is limited to 80% of taxable income
  • State NOLs may differ from federal and may have different rules around utilization

A section 382 analysis is generally necessary to determine whether a corporation has undergone one or more changes in ownership that could limit their utilization of NOLs and other attributes. Such an analysis can be complex from factual and technical perspectives, and calculations are not always intuitive.

Corporations that have consistently incurred losses prior to the new section 174 rules being effective may have not performed the necessary analysis to determine whether NOLs are limited and to substantiate that determination. This creates risk in the event NOLs are needed to offset taxable income in a pre-closing period, or if the buyer is factoring the tax attributes into their valuation.

A buyer and their advisor should consider whether NOLs and other attributes are available to use against the taxable income created by section 174. To the extent pre-closing tax liabilities are anticipated but unpaid, proper provisions should be included in the purchase agreement. Additionally, to the extent the corporation has failed to adopt proper methods for the 2022 tax year, the buyer should consider the effects of correcting the method, including possible recognition of a section 481(a) adjustment in post-closing tax periods.

Finally, there may be opportunities and risks with respect to the section 41 R&D tax credit. If the target has been claiming an R&D tax credit, consider whether the credit was appropriately calculated and whether proper documentation has been maintained. For targets that have not been claiming a credit, or have not been capturing all available credits, opportunities may exist. It is important to note that not all costs required to be capitalized under section 174 are eligible costs for purposes of the R&D tax credit.

Moving the enterprise forward with eGRC

Buyers can avoid surprises and preserve cash flows by being mindful of the tax law changes when preparing operating models and projecting cash taxes.

Asset deals

In a transaction structured as a taxable asset acquisition, accounting methods generally do not carry over to the buyer. Buyers will be able to elect their own methods, including with respect to section 174.

Intangible assets acquired in an asset acquisition are generally capitalized under section 197 and amortized over 15 years. This is true of internally developed software, irrespective of how the target treats section 174 costs.

In a transaction structured as a taxable asset acquisition for both tax and legal purposes, in most cases a buyer is not expected to inherit historical federal income tax liabilities of the target. However, a buyer may inherit historical income tax liabilities in transactions that are equity acquisitions for legal purposes but deemed asset acquisitions for tax purposes, such as stock purchases with section 338 elections, or acquisitions of disregarded entities.

Many variations on tax structure can exist, and buyers and their advisors should consider how structure informs risks and affects treatment of section 174 costs.

Modeling and projecting under the new section 174 rules

Buyers can avoid surprises and preserve cash flows by being mindful of the tax law changes when preparing operating models and projecting cash taxes. The impact on timing of cash taxes can be significant, and deferral of deductions may cause cash outflows for taxes to be unexpectedly high as a percentage of EBITDA or book net income metrics.

In addition to the change to R&D expensing, recent changes to the section 163(j) rules on interest deductibility and section 168(k) bonus depreciation rules may also increase projected cash taxes.

For tax years beginning after Dec. 31, 2021, allowable interest expense under section 163(j) is equal to 30% of tax basis EBIT. Previously, the calculation was based on 30% of tax basis EBITDA.

And while the TCJA initially permitted 100% expensing for qualified depreciable property placed in service, this bonus percentage will be reduced by 20% each year beginning in 2023, with bonus depreciation fully phased out in 2027.

These unfavorable changes, combined with more expensive borrowing in the current interest rate environment, place an increased emphasis on cash tax modeling for companies and their investors.

The takeaway

It is critical that buyers and their advisors evaluate the impact of new section 174 capitalization rules when purchasing a business that engages in R&D or software development. The new rules could significantly and negatively affect the target’s tax posture, which could subject the buyer to unwelcome tax costs and consequences. Consider historical exposures, purchase agreement negotiations and tax projections as part of updated tax diligence processes.

Let’s Talk!

Call us at (541) 773-6633 (Oregon), (208) 373-7890 (Idaho) or fill out the form below and we’ll contact you to discuss your specific situation.





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This article was written by Bill Jachym and originally appeared on Apr 24, 2023.
2022 RSM US LLP. All rights reserved.
https://rsmus.com/insights/services/merger-acquisition/ma-considerations-resulting-from-the-new-required-tax-treatment.html

The information contained herein is general in nature and based on authorities that are subject to change. RSM US LLP guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. RSM US LLP assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein. This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer.

RSM US Alliance provides its members with access to resources of RSM US LLP. RSM US Alliance member firms are separate and independent businesses and legal entities that are responsible for their own acts and omissions, and each are separate and independent from RSM US LLP. RSM US LLP is the U.S. member firm of RSM International, a global network of independent audit, tax, and consulting firms. Members of RSM US Alliance have access to RSM International resources through RSM US LLP but are not member firms of RSM International. Visit rsmus.com/aboutus for more information regarding RSM US LLP and RSM International. The RSM(tm) brandmark is used under license by RSM US LLP. RSM US Alliance products and services are proprietary to RSM US LLP.

KDP is a proud member of RSM US Alliance, a premier affiliation of independent accounting and consulting firms in the United States. RSM US Alliance provides our firm with access to resources of RSM US LLP, the leading provider of audit, tax and consulting services focused on the middle market. RSM US LLP is a licensed CPA firm and the U.S. member of RSM International, a global network of independent audit, tax and consulting firms with more than 43,000 people in over 120 countries.

Our membership in RSM US Alliance has elevated our capabilities in the marketplace, helping to differentiate our firm from the competition while allowing us to maintain our independence and entrepreneurial culture. We have access to a valuable peer network of like-sized firms as well as a broad range of tools, expertise, and technical resources.

For more information on how KDP LLP can assist you, please call us at:

Oregon Office:
(541) 773-6633

Idaho Office:
(208) 373-7890

How people, processes and technology propel firms forward

Professional services firms should focus on people, process and technology to enhance the employee experience.

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How people, processes and technology propel firms forward

ARTICLE | April 22, 2023 | Authored by RSM US LLP

Like everything important in life and business, it all starts with the people.

Professional services companies thrive only to the extent that their employees succeed. To create a workforce that is engaged and performing at a superior level, organizations must consider the interplay of people, process and technology. Addressing these three critical components as one interlocking function can help companies tap into their employees’ full potential.

People: Level up your talent through mentorship and training

In today’s dynamic job market, employees of professional services firms are looking for opportunities to develop their skills and advance their career. Of course, the specifics can vary, depending on the company’s needs and the capabilities of its staff members.

For that reason, leaders must have honest, in-depth conversations with their talent about their goals and career path, while fostering a culture of mentorship.

But to have a productive conversation, leaders must understand the company’s vision, the nuances of the marketplace and the employee’s abilities. Mentoring someone involves more than offering the occasional tip. It means discussing their goals, coaching them, and helping them progress toward realistic, relevant accomplishments to advance their career.

What skills does the employee want to learn? Where are the opportunities for growth within the company? What does the employee like or dislike about the job?

Those questions are just for starters. And in today’s tight labor market, professional services firms must answer a fundamental question about themselves: Why should the employee stay with the company?

Mentors must be sincere and open with their proteges, clearly communicating the organization’s intangible benefits as well as tangible career paths. There should be no mystery about how an employee can advance within the company.

Companies should also invest in professional development and training opportunities that keep employees informed about industry trends and help them develop new skill sets. This will help ensure they know what’s necessary to succeed in their role, while also providing incentives for them to stay with the team for the long term.

Prioritize learning and development

57%

of workers want to update their skills

61%

say upskilling opportunities are an important reason to stay at their job

71%

say job training and development increased their satisfaction

A firm’s employees are the driving force behind a business. Having people with the right skills in the right positions allows the company to deploy those skills rapidly to meet the demands of the marketplace.

Process: Help people reach their goals through process improvement

When it comes to streamlining procedures, companies want to achieve the twin goals of improving efficiency and reducing employee stress. Fortunately, these goals are complementary.

For example, automation software can speed up processes, make systems more consistent and eliminate human errors. As a result, workers who are no longer burdened with repetitive or tedious tasks will be free to focus on higher-value tasks, which has the additional benefit of improving employee morale. Automating procedures can make processes more efficient while allowing staff members to gain more meaning from their job.

Another way to improve processes is to outsource certain tasks. Professional services firms often work with third-party providers that handle the company’s information technology, human resources, or finance and accounting operations.

The goal is not to replace employees, but to obtain outside help from people who are well-versed in functions that may be beyond the core abilities of the employee. After all, an IT professional who works for a managed service provider is always going to be better at spotting bugs in a system than a staff member who moonlights as a techie only when problems arise. Outsourcing job functions allows employees to stay on their career path and elevate their skill set, rather than forcing them to muddle through unfamiliar or repetitive tasks.

Technology: Invest in technology to enhance the talent experience

Investing in more efficient platforms and applications can seem daunting to many professional services firms. However, utilizing technology is essential to ensure that the company has a dynamic workforce capable of meeting the challenges of an evolving environment.

Technology doesn’t just help firms muddle through—it drives progress and propels companies to success.

The right technology makes employees’ jobs easier and creates a better work-life balance. In turn, employee satisfaction increases, creating a cycle of efficiency and productivity.

In addition to enabling people to work more effectively, technology can help employees gain a better understanding of their company and improve their interactions with stakeholders. If technology doesn’t accomplish these goals, however, it just becomes an expensive toy.

The key is to invest in tech solutions that deliver the best return on investment for the organization. Much depends on the needs and size of the organization—but in all cases, technology exists that can eliminate inefficiencies and generate useful data.

Unfortunately, many professional services companies rely on antiquated or ad hoc systems. Settling for “good enough” robs companies of timely, accurate data that helps them make informed decisions.

Some organizations even have an institutional reluctance, bordering on technophobia, that prevents them from investing in cutting-edge applications.

However, the pandemic proved that technology is not the enemy. Think of how many companies thrived by using Zoom, Microsoft Teams or another collaboration app to keep their employees focused and engaged. Embracing technology—not as a savior but as a tool for excellence—is a sign of a successful organization.

By itself, technology won’t solve every problem—but it can empower people to perform their job more productively and efficiently, enabling greater success for individuals and the entire organization.

Putting it all together

Facing a dynamic labor market, uncertain economic conditions and unprecedented technological changes, professional services firms should focus on improving critical areas of their business to safeguard their workforce and ensure an unrivaled talent experience.

People

Retain talent by establishing transparent career paths, offering educational and training opportunities, and fostering a culture of mentorship.

Process

Streamline procedures by automating processes or create efficiencies through outsourcing.

Technology

Invest in technology that improves collaboration and enables people to succeed in their role.

Let’s Talk!

Call us at (541) 773-6633 (Oregon), (208) 373-7890 (Idaho) or fill out the form below and we’ll contact you to discuss your specific situation.





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This article was written by Karen Wiltgen, Jen Hartman and originally appeared on Apr 22, 2023.
2022 RSM US LLP. All rights reserved.
https://rsmus.com/insights/industries/professional-services/how-people-process-technology-bolster-workforces-propel-forward.html

RSM US Alliance provides its members with access to resources of RSM US LLP. RSM US Alliance member firms are separate and independent businesses and legal entities that are responsible for their own acts and omissions, and each are separate and independent from RSM US LLP. RSM US LLP is the U.S. member firm of RSM International, a global network of independent audit, tax, and consulting firms. Members of RSM US Alliance have access to RSM International resources through RSM US LLP but are not member firms of RSM International. Visit rsmus.com/aboutus for more information regarding RSM US LLP and RSM International. The RSM(tm) brandmark is used under license by RSM US LLP. RSM US Alliance products and services are proprietary to RSM US LLP.

KDP is a proud member of RSM US Alliance, a premier affiliation of independent accounting and consulting firms in the United States. RSM US Alliance provides our firm with access to resources of RSM US LLP, the leading provider of audit, tax and consulting services focused on the middle market. RSM US LLP is a licensed CPA firm and the U.S. member of RSM International, a global network of independent audit, tax and consulting firms with more than 43,000 people in over 120 countries.

Our membership in RSM US Alliance has elevated our capabilities in the marketplace, helping to differentiate our firm from the competition while allowing us to maintain our independence and entrepreneurial culture. We have access to a valuable peer network of like-sized firms as well as a broad range of tools, expertise, and technical resources.

For more information on how KDP LLP can assist you, please call us at:

Oregon Office:
(541) 773-6633

Idaho Office:
(208) 373-7890

Hotel market shows continued resilience with a focus on luxury

The hospitality industry remains challenged despite strong performance driving investment in the luxury hotel market.

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Hotel market shows continued resilience with a focus on luxury

ARTICLE | April 20, 2023 | Authored by RSM US LLP

The hospitality sector, in particular, is sensitive to current challenges in the broader economy: rising interest rates, higher inflation and a tight labor market. Even so, the industry is making strides in the post-pandemic new normal as the focus shifts to high-end, experience-rich destinations in the luxury segment.

In the early days of the pandemic, coastal and resort hotels with lighter restrictions benefited from travelers escaping quarantine. Economy and extended-stay properties, which accommodated essential workers in need of refuge, fared better than amenity-rich properties hurt by concerns around social distancing. Three years later, upscale properties are now leading a rebound, having enjoyed a renaissance built on steady room rates, distinctive accommodations and an affluent market that is less price sensitive in an inflationary economy. The luxury segment is expected to remain robust amid the broader economic slowdown.

Luxury rates and consumer expectations fly high

As consumer preferences have shifted from goods to services, more travelers seek unique lifestyle experiences, and the hospitality sector appears to be meeting demand. According to data analytics firm STR, U.S. hotels reached 62.8% occupancy in early March, exceeding 2022 levels and tracking close to 2019. Room prices are up, with the average daily rate 14% higher than in 2019 at $151 and revenue per available room (RevPAR) 8% higher at $95.

Having learned from mistakes made during the global financial crisis of 2007-2009, owners and operators of upscale properties maintained their rates through the pandemic downturn to preserve pricing power. As a result, when restrictions were lifted, and travel began to normalize, guests were used to paying daily rates without a significant discount. A reduced labor force and limited room supply allowed luxury hotels to maximize their margins and recover more quickly. By August 2021, RevPAR was even with 2020 levels and by December 2021, it had more than doubled. We expect the trend to continue throughout 2023 as the focus on wellness and healing, fresh dining options, unique excursions and sustainability continue to help the luxury space.

Labor gaps result in diminished hospitality experience

As demand returns for all hotel segments, owners and operators are battling an ongoing labor crisis. Even though hospitality job reports have consistently been favorable, the composition of workers in the market leaves the industry searching for talent. According to the U.S. Bureau of Labor Statistics, employment increased by 311,000 jobs in February, including 105,000 positions in leisure and hospitality, consistent with an average monthly jobs gain of 91,000 since April 2020. Despite these gains, job openings in the sector rose to 1.7 million available positions through February 2022, as filling available roles remains challenging, and some workers previously committed to the sector have fled for opportunities in other industries. Labor market stress is reflected in record pay rates of roughly $20 per hour and an inability to match open jobs to workers with appropriate skills. As hiring costs rise for entry-level and middle-management positions, higher labor dollars reduce hotel profit margins at the expense of a diminished hospitality experience.

TAX TREND: Workforce

For hospitality companies trying to find and keep entry-level and middle-management employees, developing a compensation philosophy centered on total rewards instead of record-high hourly pay rates may effectively balance costs with offerings that match workers’ preferences. Retirement programs, education opportunities or assistance and subsidized transportation benefits are just a few of many common offerings with tax implications.

Despite challenges related to the labor market, technology and capital investment have bridged the gaps and allowed hotel operators to continue providing quality experiences. Although the overall labor market remains strong, the hospitality industry faces an ongoing struggle to find talent, which will shape how travelers interact with staff and onsite amenities.

Nominal rates and RevPAR exceed 2019 levels

Nominal rates and RevPAR exceed 2019 levels.png

12-month % change–revenue per available room (RevPAR)

12-month % change–revenue per available room (RevPAR)

Capital markets hurt by interest rates and banking disruption

The outlook for capital markets activity in the hospitality sector is cautious going into the second half of 2023. A series of interest rate hikes by the Federal Reserve has made the cost of debt and equity significantly more expensive. Therefore, a slowdown in transactional activity is expected across the real estate industry, including hospitality. Meanwhile, recent weakness in the U.S. banking sector, underscored by the demise of several regional banks, threatens financial stability and liquidity prospects for hotel investors.

TAX TREND: Workforce

Relatively high-interest rates, combined with an unfavorable change in tax law, have left many businesses paying more interest while seeing a decrease in their tax deductions for interest expense. As a result, real estate investors seeking to maximize their cash after taxes may be compelled to make an irrevocable election that excepts their business from the limit on the amount of business interest they can deduct from their taxable income. 

While luxury hotel transactions dominated headlines in 2022, they accounted for just 3% of the total number of transactions. According to CoStar data, activity was heavily concentrated at the lower and middle segments of the market. Economy hotels represented 38% of trades, followed by the midscale tier at 13%, with individual investors driving the bulk of transactional activity. The outlook for 2023 calls for strong investor interest in the luxury segment and fewer prospects for business and economy hotels as demand has waned nationwide. Meanwhile, increasing costs for debt, building materials and construction labor have muted new supply.

As lending requirements have tightened, private-label hotel commercial mortgage-backed security (CMBS) issuances have dropped and securitized note rates have increased. While mezzanine and other debt financing remain available in the marketplace, higher interest rates, required capital improvements deferment and depleted replacement reserves may prove too much for current owners to recapitalize their positions pushing transactions into the second half of 2023.

TAX TREND: Workforce

Given the potential emergence of distressed assets, understanding the tax implications of loan defaults can inform your decisions and prevent surprises. In the case of a loan default, a borrower might have to recognize income and pay tax despite not having the cash.

Commercial mortgage-backed security (CMBS) issuance trends

Commercial mortgage-backed security (CMBS) issuance trends

The takeaway

While luxury properties have enjoyed a strong performance and investor favor, all hospitality segments remain challenged by inflation, a shortage of skilled labor and consequently diminished consumer experiences. Technology solutions that offset labor shortages and those offering data mining and operational efficiencies can help hotel operators and owners mitigate these challenging trends. The capital markets outlook for 2023 and 2024 will be diverse as strong assets potentially hit the market due to maturating debt. Meanwhile, increasing debt, materials and labor costs will mute hotel supply growth. 

Let’s Talk!

Call us at (541) 773-6633 (Oregon), (208) 373-7890 (Idaho) or fill out the form below and we’ll contact you to discuss your specific situation.





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This article was written by Laura Dietzel, Ryan McAndrew and originally appeared on 2023-04-20.
2022 RSM US LLP. All rights reserved.
https://rsmus.com/insights/industries/real-estate/hotel-market-shows-continued-resilience-with-focus-on-luxury.html

RSM US Alliance provides its members with access to resources of RSM US LLP. RSM US Alliance member firms are separate and independent businesses and legal entities that are responsible for their own acts and omissions, and each are separate and independent from RSM US LLP. RSM US LLP is the U.S. member firm of RSM International, a global network of independent audit, tax, and consulting firms. Members of RSM US Alliance have access to RSM International resources through RSM US LLP but are not member firms of RSM International. Visit rsmus.com/aboutus for more information regarding RSM US LLP and RSM International. The RSM(tm) brandmark is used under license by RSM US LLP. RSM US Alliance products and services are proprietary to RSM US LLP.

KDP is a proud member of RSM US Alliance, a premier affiliation of independent accounting and consulting firms in the United States. RSM US Alliance provides our firm with access to resources of RSM US LLP, the leading provider of audit, tax and consulting services focused on the middle market. RSM US LLP is a licensed CPA firm and the U.S. member of RSM International, a global network of independent audit, tax and consulting firms with more than 43,000 people in over 120 countries.

Our membership in RSM US Alliance has elevated our capabilities in the marketplace, helping to differentiate our firm from the competition while allowing us to maintain our independence and entrepreneurial culture. We have access to a valuable peer network of like-sized firms as well as a broad range of tools, expertise, and technical resources.

For more information on how KDP LLP can assist you, please call us at:

Oregon Office:
(541) 773-6633

Idaho Office:
(208) 373-7890

Interest rates pose challenges for builders, but opportunities are on the horizon

Residential construction sees a favorable long-term outlook despite ongoing challenges affecting the housing market.

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Interest rates pose challenges for builders, but opportunities are on the horizon

ARTICLE | April 20, 2023 | Authored by RSM US LLP

After a drastic shift in the second half of 2022, the housing market started with a strong foothold in 2023 once builder sentiment rose following reports of an early spring selling season and stronger-than-expected sales.

The outsize impact of interest rates

Last year, mortgage rates climbed much more rapidly than expected, reaching nearly 7.5% in September after starting the year below 3.5%. The rapid rise in mortgage rates led to a substantial slowdown in demand, as potential homebuyers could no longer afford monthly mortgage payments.

This increase caused many to rethink their buying decisions and created housing affordability issues across the United States.

Affordability remains a top concern for the housing market as monthly mortgage payments (assuming a 20% down payment) are up 38% from a year ago for a median-priced new home and 40% for a median-priced existing home. Despite these increases, pent-up demand, the use of builder incentives and some easing in mortgage rates have brought some consumers back to the market.

U.S. housing affordability

U.S. housing affordability

This market change was evident in January as mortgage rates fell to the low 6s, spurring activity; however, the volatility in mortgage rates has since continued. In February and early March, rates rose once again as new macroeconomic data, including a better-than-expected jobs report and a surge in inflation, pointed to an overheated economy and additional action needed by the Federal Reserve to hit its inflation target of 2%.

Recently,10-year treasury yields and mortgage rates have eased. This easing signals the market is expecting further disinflation, following a hike of 25 basis points by the Fed and Chair Powell’s announcements, which indicated that the recent shocks in the financial sector are “likely to result in tighter conditions that weigh on economic activity, hiring and inflation.” As a result, mortgage rates fell from recent highs of more than 7% to below 6.5% at the end of March.

Rising interest rates have been a major headwind for builders and consumers alike, with many potential buyers priced out of the market. The composite homebuyer affordability index stood at 95.5 in the last quarter of 2022, down from 142.8 a year earlier. The first-time homebuyer affordability index was 63.3 during the last quarter of 2022, down from 94, according to the National Association of Realtors. These indices measure the ability of a family with a median income to afford a median-priced home, assuming a 20% down payment (10% for first-time buyers); a value of 100 indicates just enough income and anything below it indicates insufficient income.

While aspiring buyers are out there, historically high mortgage rates have pushed many to the sidelines. Recent retreats in mortgage rates will help provide relief to potential buyers bringing pent-up demand, which is already creating a quick response, as mortgage applications were up every week in March, according to data from the Mortgage Bankers Association.

Builders to proceed with caution

In March, housing permits and starts were at 1.41 and 1.42 million annualized units, respectively, above recent lows but still down from 1.88 and 1.72 million from the prior year. During the same period, single-family permits and starts were at 818,000 and 861,000 annualized units, respectively, down from 1.16 and 1.19 million a year prior.

The current U.S. housing shortage is estimated to exceed 3.5 million units; approximately 1.7 million new homes will need to be built every year through 2030 to close this housing gap.

Recent improvements to builder sentiment, resulting from a better-than-expected start to the spring season and the recent easing of mortgage rates, are expected to spur much-needed single-family housing construction activity in 2023. Although many builders remain cautious in the near term amid the instability in the banking system and monetary tightening, which could result in constraints for acquisition, development and construction loans for builders as well as make it more difficult for some mortgage borrowers to secure credit.

New housing construction

New housing construction

A shift in the composition of housing inventory creates opportunities

Even as new construction of homes has declined, the lack of existing inventory has created a significant shift in the composition of units available for sale favoring new builds. In February, new homes accounted for 436,000 units or 31% of total housing inventory, a substantial increase from pre-pandemic levels when new units available for sale generally comprised approximately 10%-15% of total inventory.

The shift toward new builds is a direct result of the mortgage “lock-in effect,” as over 90% of homeowners were estimated to have mortgage rates below current rates, as of August 2022, according to data from CoreLogic. This phenomenon has caused reluctance among current homeowners to sell their homes, limiting the resale inventory. We expect this trend will represent a more permanent shift in housing, as mortgage rates are unlikely to return to the historical lows of the pandemic period, and homeowners are less likely to trade their current mortgages for those with much higher rates.

Housing units available for sale

Housing units available for sale

The housing shortage combined with demographic shifts, including the millennial generation being at the prime homebuying age, along with a shift in the composition of existing and new homes, create a very favorable long-term outlook for residential construction. In the near term, however, mortgage rates will continue to drive much of the demand. Many buyers remain on the sidelines, and while we will see a cautious return of the housing market until mortgage rates reach a more stable terminal rate, demand for housing may not fully return.

In the meantime, residential builders need to take proactive steps. These steps include having a firm handle on their costs and key financial metrics to allow for optimal pricing models and home production. They need to closely monitor market conditions for each market in which they operate or wish to operate and invest in technology and automation to increase productivity and reduce costs.

Let’s Talk!

Call us at (541) 773-6633 (Oregon), (208) 373-7890 (Idaho) or fill out the form below and we’ll contact you to discuss your specific situation.





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This article was written by Crystal Sunbury and originally appeared on 2023-04-20.
2022 RSM US LLP. All rights reserved.
https://rsmus.com/insights/industries/construction/interest-rates-pose-challenges-for-builders-but-opportunities-on-horizon.html

RSM US Alliance provides its members with access to resources of RSM US LLP. RSM US Alliance member firms are separate and independent businesses and legal entities that are responsible for their own acts and omissions, and each are separate and independent from RSM US LLP. RSM US LLP is the U.S. member firm of RSM International, a global network of independent audit, tax, and consulting firms. Members of RSM US Alliance have access to RSM International resources through RSM US LLP but are not member firms of RSM International. Visit rsmus.com/aboutus for more information regarding RSM US LLP and RSM International. The RSM(tm) brandmark is used under license by RSM US LLP. RSM US Alliance products and services are proprietary to RSM US LLP.

KDP is a proud member of RSM US Alliance, a premier affiliation of independent accounting and consulting firms in the United States. RSM US Alliance provides our firm with access to resources of RSM US LLP, the leading provider of audit, tax and consulting services focused on the middle market. RSM US LLP is a licensed CPA firm and the U.S. member of RSM International, a global network of independent audit, tax and consulting firms with more than 43,000 people in over 120 countries.

Our membership in RSM US Alliance has elevated our capabilities in the marketplace, helping to differentiate our firm from the competition while allowing us to maintain our independence and entrepreneurial culture. We have access to a valuable peer network of like-sized firms as well as a broad range of tools, expertise, and technical resources.

For more information on how KDP LLP can assist you, please call us at:

Oregon Office:
(541) 773-6633

Idaho Office:
(208) 373-7890

Fewer vehicles to qualify for clean vehicle credit in the short term

New rules for EV credit reduce the number of eligible models after Apr. 17, 2023. The list of eligible models is likely to grow.

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Fewer vehicles to qualify for clean vehicle credit in the short term

TAX ALERT | April 19, 2023 | Authored by RSM US LLP

Executive summary: Fewer models to qualify for clean vehicle credit in short term

Treasury and the IRS issued proposed regulations that impact the credit calculation for vehicles eligible for the clean vehicle credit. These regulations affect certain vehicles placed in service after Apr. 17, 2023. In addition to other requirements imposed by changes to the clean vehicle credit through the Inflation Reduction Act (IRA), new critical mineral and battery component requirements determine the value of the credit for an eligible vehicle. For now, there are fewer vehicle models that yield a full or partial clean vehicle if they are placed in service after Apr. 17, 2023. The number of qualifying vehicles is likely to increase as manufacturers strive to satisfy the requirements, maximizing credits for their customers.

Fewer vehicles to qualify for clean vehicle credit in the short term

Critical mineral and battery component requirements

The clean vehicle credit is available for the purchase of certain plug-in hybrid and electric vehicles. Prior to the IRA, the credit was determined as a function of a qualifying vehicle’s battery capacity in kilowatt hours. The IRA’s modifications to the credit included new requirements on the origin of critical minerals and battery components used in a qualifying vehicle. Each requirement, if met, represents a $3,750 component of the maximum credit of $7,500 per vehicle. The new critical mineral and battery component requirements apply to vehicles placed in service after Apr. 17, 2023. Additional requirements are imposed on both vehicles and buyers.

Current list of credit-eligible vehicles

A qualified manufacturer that asserts its vehicles are eligible for the clean vehicle credit must certify their eligibility to the IRS through periodic written reports. Satisfaction of the critical mineral and battery component requirements is included in the manufacturer’s certification. 

The IRS publishes a list of credit-eligible vehicles. Currently, the list is available on a U.S. Department of Energy website. As of this writing, vehicles placed in service after Apr. 17, 2023 are eligible for credits as follows:

Model year

Make and model

Credit amount

MSRP Limitation

2023 – 2024

Cadillac LYRIQ

$7,500

$80,000

2024

Chevrolet Blazer

$7,500

$80,000

2022 – 2023

Chevrolet Bolt

$7,500

$55,000

2022 – 2023

Chevrolet Bolt EUV

$7,500

$55,000

2024

Chevrolet Equinox

$7,500

$80,000

2024

Chevrolet Silverado

$7,500

$80,000

2022 – 2023

Chrysler Pacifica PHEV

$7,500

$80,000

2022 – 2023

Ford E-Transit

$3,750

$80,000

2022 – 2023

Ford Escape Plug-in Hybrid

$3,750

$80,000

2022 – 2023

Ford F-150 Lightning (Extended Range Battery)

$7,500

$80,000

2022 – 2023

Ford F-150 Lightning (Standard Range Battery)

$7,500

$80,000

2022 – 2023

Ford Mustang Mach-E (Extended Range Battery)

$3,750

$80,000

2022 – 2023

Ford Mustang Mach-E (Standard Range Battery)

$3,750

$80,000

2022 – 2023

Jeep Grand Cherokee PHEV 4xe

$3,750

$80,000

2022 – 2023

Jeep Wrangler PHEV 4xe

$3,750

$80,000

2022 – 2023

Lincoln Aviator Grand Touring

$7,500

$80,000

2022 – 2023

Lincoln Corsair Grand Touring

$3,750

$80,000

2022 – 2023

Tesla Model 3 Performance

$7,500

$55,000

2022 – 2023

Tesla Model 3 Standard Range Rear Wheel Drive

$3,750

$55,000

2022 – 2023

Tesla Model Y All-Wheel Drive

$7,500

$80,000

2022 – 2023

Tesla Model Y Long Range All-Wheel Drive

$7,500

$80,000

2022 – 2023

Tesla Model Y Performance

$7,500

$80,000

Washington National Tax takeaways

The list of credit-eligible vehicle models is expected to expand as manufacturers comply with the critical mineral and battery component requirements for models produced in the future. Further, it is expected that the IRS and Department of Energy will maintain an updated list for consumers to identify eligible vehicles. Fortunately for vehicle buyers, use of the Department of Energy list and reliance on seller’s reports accompanying credit-eligible vehicles should reduce confusion regarding credit eligibility.

Let’s Talk!

Call us at (541) 773-6633 (Oregon), (208) 373-7890 (Idaho) or fill out the form below and we’ll contact you to discuss your specific situation.





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This article was written by Christian Wood, Deborah Gordon, Brent Sabot and originally appeared on 2023-04-19.
2022 RSM US LLP. All rights reserved.
https://rsmus.com/insights/tax-alerts/2023/Fewer-vehicles-qualify-clean-vehicle-credit-short-term.html

The information contained herein is general in nature and based on authorities that are subject to change. RSM US LLP guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. RSM US LLP assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein. This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer.

RSM US Alliance provides its members with access to resources of RSM US LLP. RSM US Alliance member firms are separate and independent businesses and legal entities that are responsible for their own acts and omissions, and each are separate and independent from RSM US LLP. RSM US LLP is the U.S. member firm of RSM International, a global network of independent audit, tax, and consulting firms. Members of RSM US Alliance have access to RSM International resources through RSM US LLP but are not member firms of RSM International. Visit rsmus.com/aboutus for more information regarding RSM US LLP and RSM International. The RSM(tm) brandmark is used under license by RSM US LLP. RSM US Alliance products and services are proprietary to RSM US LLP.

KDP is a proud member of RSM US Alliance, a premier affiliation of independent accounting and consulting firms in the United States. RSM US Alliance provides our firm with access to resources of RSM US LLP, the leading provider of audit, tax and consulting services focused on the middle market. RSM US LLP is a licensed CPA firm and the U.S. member of RSM International, a global network of independent audit, tax and consulting firms with more than 43,000 people in over 120 countries.

Our membership in RSM US Alliance has elevated our capabilities in the marketplace, helping to differentiate our firm from the competition while allowing us to maintain our independence and entrepreneurial culture. We have access to a valuable peer network of like-sized firms as well as a broad range of tools, expertise, and technical resources.

For more information on how KDP LLP can assist you, please call us at:

Oregon Office:
(541) 773-6633

Idaho Office:
(208) 373-7890

Why the dollar remains the world’s reserve currency, and will stay that way

We find the recent discussion around the end of the dollar dominance bereft of any linkage to the reality of international finance.

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Why the dollar remains the world’s reserve currency, and will stay that way

REAL ECONOMY BLOG | April 17, 2023 | Authored by RSM US LLP

Recent talk that China, India and Russia are settling purchases of oil in non-dollar denominations has generated speculation that the dollar’s days as the world’s reserve currency are ending.

The recent discussion around the end of the dollar’s dominance is bereft of any linkage to the reality of international finance.

This is nothing new. There were similar discussion during the financial crisis 15 years ago and, more recently, during the cryptocurrency bubble.

Now, most measures of dollar valuation suggest continued dollar strength.

Using Citi’s real effective exchange rate index, the American dollar stands at 103.81, below its recent peak of 111.90 in October. Yet 103.81 is well above where it has been for most of the past 20 years. The index measures the value of the dollar where 100 is neutral.

Citi dollar index

The dollar accounted for roughly 60% of global currency reserves at the end of last year, which is down from its recent peak of just above 70% in the first part of this century but well above the 50% of 30 years ago.

We find the recent discussion around the end of the dollar dominance bereft of any linkage to the reality of international finance and understanding of the dollar’s role as the anchor of the rules-based order that governs global economics.

Economies like China that run surpluses need dollar-based demand from the United States to make up for their own weak consumption and high savings rates.

Rather, the recent conversation is stoked by global grievances about the relative disparity of economic power and the dead end in which some economies find themselves.

While these economies may desire an end to the dollar’s dominance, they are experiencing major setbacks on their own. Calling for an end to dollar preeminence is premature at best.

The global financial system rests upon the stability of the dollar and the large trade deficit the U.S. runs.

In essence, the United States exports dollar stability for goods and services at a cheaper price and enhances the welfare of its citizens.

In return, the major trading economies get to hold a currency that is sounder than they possess—think of the Chinese yuan, which relies upon the depth of global liquidity markets based on the dollar to maintain that country’s currency regime. That reliance, in turn, reinforces the dollar’s hegemony.

In short, the economies that run surpluses need that dollar-based demand from the United States to make up for their own weak consumption and high savings rates.

China is a case in point. For China, which accounts for 2.7% of global reserves, to become a true reserve currency, it would have to liberalize the yuan. Such a loosening would result in a decline in the ability of the regulatory authority to control credit, relinquishing any control of its capital account and current account.

China would have to be willing to alter its economic framework so that its economy plays the same role as that of the United States. Given China’s current political arrangements, that will not happen. And the dollar will remain dominant.

Moreover, the soft power of the United States is too often discounted. The rule of law, foreign direct investment—with the notable exception of China and Russia—as well as the dollar’s support of the rules-based order all reinforce U.S. economic and financial power.

Global foreign exchange data

The vast majority of international trades, almost 90%, are invoiced in U.S. dollars or euros, according to a recent analysis by the Federal Reserve Bank of New York.

As of the end of last year, the U.S. dollar accounted for 60% of total allocated currency reserves held by central banks.

That corresponds to the 80% of total foreign exchange reserves allocated to the dollar and euro held by central banks at the end of last year. The dollar accounted for 60% and the euro 20%.

China, Russia, India and Saudi Arabia are not in any economic shape to support such a change in the rules-based order.

Despite the global economic growth over the past three decades, the current order is simply not going to change at the scale necessary to supplant the American dollar and the global order that rests upon its foundation.

There are only three other economies that have some the qualities needed to support a reserve currency: the euro area, Japan and the United Kingdom.

But none of those have financial markets with the depth and liquidity to form the backbone of international finance and trade.

In the early 2000s, the percentage of dollar and euro reserves was as high as 90%, with the gradual decline since then most likely because of increased trade among smaller economies and, more important, their reduced reliance on the foreign issuance of debt.

The IMF also notes that as stockpiles of foreign currency reserves grow, the case for portfolio diversification has grown as well.

Currencies of smaller economies that have not traditionally figured prominently in reserve portfolios but offer high returns and stability— like the Australian and Canadian dollars, Swedish krona and South Korean won—account for three quarters of the shift from dollars.

Other IMF analysis notes that the dollar is the dominant reserve currency by default. The absence of an alternatives to the safety of dollar-trade invoicing, international funding markets, and the large supply of guaranteed Treasury bonds suggests that the dollar’s role in the global economy is secure.

Foreign exchange reserves

What determines a reserve currency

A reserve currency needs to be stable and safe, a store of value and a medium of exchange, and widely accepted and trusted.

This is according to an analysis by Vivek Joshi writing in India’s Sunday Guardian, who also notes additional societal and economic criteria for a global reserve currency. These include:

  1. The stability of the political system of the issuing country.
  2. The size and prospects of the economy.
  3. Global integration of its markets and economy.
  4. A transparent and open system.
  5. A credible legal system.
  6. The quality of its sovereign debt.
  7. The ability to bear costs associated with a reserve currency.
  8. The size, depth and liquidity of financial markets.

There is good reason for the shared dominance of the dollar and the euro, and, to a lesser extent, the Japanese yen and the British pound.

They represent the major economic centers of the world and operate within the rule of law.

There is good reason that other currencies do not yet qualify. They are either too small (Switzerland), operate under totalitarian regimes (Russia and China), or allow for protectionism (India).

Finally, a reserve currency needs to be market-based, free-floating and, most important, stable. That rules out cryptocurrencies that are prone to wild swings and live outside the regulatory system.

There have been two major reserve currencies in modern times: the British pound until World War II, and the American dollar for the past 75 years.

The euro has gained status since its inception as a single currency in 1999, now bolstered by the increase in transaction demand for the euro from developing economies in Eastern Europe and Africa.

Foreign exchange reserves by currency

Stability of the dollar

The traditional U.S. dollar index is the weighted average of the exchange rates of six developed economies: the euro area, Japan, the United Kingdom, Canada, Sweden and Switzerland.

The euro has a weight of 58% in the dollar index and a correlation coefficient of 0.98 based on monthly values of the dollar index and the euro since 1980.

Since 1990, the dollar index (and the euro) have experienced three periods of trading within narrow ranges, interrupted by consequential events that have altered the demand for U.S. assets or the mix of monetary and fiscal policies.

As we show, the pattern of range-trading followed by a breakout of the exchange rates became apparent when advances in desktop computing created the technology boom in the 1990s.

A bust followed, along with a period of the dollar range trading at a lower level from 2005 to 2015, as the sluggish U.S. economic recovery trudged along.

Late 2015 was the next turning point when the Federal Reserve began to normalize interest rates while the monetary authorities in Europe and Japan kept rates at or below zero.

That shift in monetary policy provided a dramatic boost to the dollar as it quickly moved to a higher trading range that lasted until March of last year.

This most recent breakout was the result of the dramatic introduction of a dollar-friendly policy mix last year.

The American government was in the midst of the greatest fiscal response to an economic crisis since the Great Depression when the Federal Reserve rapidly hiked its policy rate. The dollar soared while the European Central Bank had a lagged response to inflation and the Bank of Japan maintained its yield-curve control.

The mix of tightening monetary policy and expansive fiscal spending would push U.S. interest rates higher. With interest rates still near zero in Japan and Europe, that would make the dollar and dollar-denominated assets that much more attractive.

Global investors looking for higher returns on investments in U.S. securities and business opportunities, augmented by the self-fulfilling higher currency return, flocked into dollar-denominated assets.

Dollar range trading periods

Where do we go from here?

The differences in monetary policy between the United States and Europe were unlikely to last forever, with the dollar’s peak most likely occurring last September and with the euro now trading back within its 2015-22 range.

We can attribute the strengthening of the euro over the past seven months to the shrinking spread between the policy rates of the Fed and the European Central Bank as the ECB continues to respond to its 10% inflation rate.

There is also the newfound ability of Europe to survive the winter with diminished supplies of energy and its efforts to expand NATO. All of this is buffered by the uncertainty surrounding the war in Ukraine.

We do not expect that an economic slowdown will drastically affect the relative policy mixes of the United States and its trading partners.

Instead, the most important factor with regard to exchange rate stability has been the synchronization of economic growth and the coordination of monetary policy among developed nations. This is unlikely to change.

There are bound to be deviations in policy (Japan’s likely end to yield-curve control) that will continue to affect individual currencies.

And there will be differences in the transaction demand for currencies, with the currencies of economies dependent on resource extraction (see Canada and Australia) more affected by trends in economic growth and in particular the price of energy (see Japan again).

Still, we need to recognize that there have been large jumps in the dollar’s value that we attribute to innovation breakthroughs or to financial busts or to consequential policy changes that have affected the demand for U.S. assets.

Since 2015, the range of dollar trading has been between $1.05 and $1.20 against the euro, with a $1.12 center of gravity.

By any measure, the dollar at $1.10 is within range of its longer-term average value. Its movements beyond here will be dependent on inflation, economic growth and monetary policy all relative to what happens in the rest of the world.

Whether it breaks out below or above its recent range will depend on the next round of innovation or the next crisis.

The next crisis could occur as early as June. The debt-ceiling debate will devolve into an existential crisis only if the Congress allows the United States to default on its debts this summer or if it allows the dollar to suffer from a thousand cuts if this stumbling block is allowed to exist in perpetuity.

There are no viable or readily available alternatives to the U.S. dollar being the reserve currency. The result would be chaos in international trade and finance, with the cost borne by American businesses and consumers.

We also expect to hear calls for the abandonment of the regulation provided by central banks and the abandonment of traditional currencies in favor of cryptocurrencies.

While crypto advocates can explain away the instability as growing pains, and yes, traditional currencies fluctuate according to their demand, that demand is based on economic and societal factors underlying the currency and not purely on speculative behavior.

Range-trading periods for dollar

Previous attempts to de-dollarize

The use by the United States, European Union and Japan of its prodigious financial and economic power to address the Russian invasion of Ukraine has rekindled the ideal of de-dollarization.

This is not exactly a new phenomenon. Latin American and Middle Eastern economies have attempted to exit the dollar-based system.

Since the 1970’s Latin American nations like Chile and Venezuela have tried to exit the dollar-based global financial order. Venezuela has for some time attempted to purchase oil in Chinese yuan.

During that past half century, Iraq and Libya attempted to find a solution through the euro and a pan-African solution.

And we should all remember the entreaties by Japan in the late 1980’s for the United States to consider a broader role for the yen before the bursting of the Japanese financial bubble.

That request was politely rebuffed by the Reagan administration. And one should expect no different from the current and subsequent American governments.

While we recognize that the international economy has been altered by geopolitical tensions, shifting supply chains and the return of industrial policy, we just do not see a major alternative to the rules-based system supported by the American dollar.

In fact, the only thing that would really alter the current international status quo would be an American default on its debt. But that is another story for another day.

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This article was written by Joseph Brusuelas and originally appeared on 2023-04-17.
2022 RSM US LLP. All rights reserved.
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