KROST Quarterly: The Manufacturing Issue - Volume 3, Issue 2 by KROST

VOLUME 3, ISSUE 2

KROST QUARTERLY M A G A Z I N E

THE MANUFACTURING & DISTRIBUTION ISSUE ACCOUNTING FOR

PPP LOANS AND FORGIVENESS

MANUFACTURERS WITH INTERNATIONAL OPERATIONS SHOULD EXPECT A TAX BILL –

PANDEMIC OR NOT

RELIEF COMES IN THE FORM OF

R&D TAX CREDITS

FOR MANUFACTURING COMPANIES

INNOVATION, POSITIVITY, AND EVOLUTION:

HOW THREE BUSINESSES ARE NAVIGATING THE PANDEMIC

WWW.KROSTCPAS.COM KROST QUARTERLY VOL. 3 ISSUE 2 - THE MANUFACTURING ISSUE

ROST

CERTIFIED PUBLIC ACCOUNTANTS & CONSULTANTS SINCE 1939

KROSTCPAs.com

Volume 3, Issue 2 / July 2020 Offices Pasadena (Headquarters) West LA Woodland Hills Phone: (626) 449-4225 Fax: (626) 449-4471 Principals Gregory A. Kniss, CPA Managing Principal Lou Guerrero, CPA, MBT Jason C. Melillo, CPA Jean Hagan So Sum Lee, CPA Douglas Venturelli, Esq. Richard Umanoff, CPA, MBA Christopher H. Gaynor, CPA, MS Production, Copy, and Design Bethany Wolfe, Editor-in-Chief Anna Chen, Editor Diana Vu, Designer and Editor Mayra Silva, Assistant Editor Jackie Do, Assistant Editor Inquiries may be sent to: admin@KROSTCPAs.com Stock Photography Adobe Stock - Used with permission

All rights reserved. No part of this publication may be reproduced, distributed, or transmitted in any form or by any means, including photocopying, recording, or other electronic or mechanical methods, without the prior written permission of the publisher, except in the case of brief quotations embodied in critical reviews and certain other noncommercial uses permitted by copyright law.

CONTENTS

4 8 12

Accounting for PPP Loans and Forgiveness By Keith Hamasaki, CPA

Manufacturers with International Operations Should Expect a Tax Bill – Pandemic or Not By Guest Contributor, Alex Martin

Foreign-Derived Intangible Income (FDII) Can Increase Cash Flow for Manufacturing Companies and Distributors with Global Operations By Evelyn Fernandez, CPA, MST

14 17 20 22

Innovation, Positivity, and Evolution: How Three Businesses are Navigating the Pandemic with Serrano Industries, Inc., Drop Labs & LumaForge

Employee Retention Credit Provides Benefits for Manufacturing Employers By Jim Estrella, CPA, MSA

Manufacturing Companies Beware: CCPA May Impact Your Business By Keith Hamasaki, CPA

Relief Comes in the Form of R&D Tax Credits for Manufacturing Companies By Guest Contributor, Michael Maroney

T H E MA N UFAC TURIN G IS S U E KROST Quarterly is a digital publication released by KROST CPAs & Consultants headquartered in Pasadena, California. Established in 1939, this full-service Certified Public Accounting and Consulting firm serves clients across a variety of industries. With a focus on recognizing opportunities and creating value, KROST equips clients with tools to make better business and financial decisions for the future.

KROST QUARTERLY VOL. 3 ISSUE 2 - THE MANUFACTURING ISSUE

INTRODUCING KROST’S MANUFACTURING & DISTRIBUTION TEAM At KROST, we embody a collaborative and educational culture where we translate complex business matters into easily understandable ideas. As a result of these core values, our Manufacturing and Distribution Industry Group provides quality business advice to support our clients’ needs. We have created a specialty suite of services that specifically caters to our manufacturing and distribution clients. We have experience servicing clients in a variety of sectors such as aerospace and defense, automotive and transportation, consumer products, food and beverage, industrial parts, wholesale distribution, and more.

Our team regularly produces KROST Insights posted to our website. This issue will highlight some of the hot topics in manufacturing, including accounting for PPP, transfer pricing, Foreign-Derived Intangible Income (FDII), R&D tax credits, and more.

Receive KROST news right to your inbox! To subscribe, click here.

KROST QUARTERLY VOL. 3 ISSUE 2 - THE MANUFACTURING ISSUE

Greg Kniss, CPA Managing Principal

MANUFACTURING

& DISTRIBUTION

Team at KROST Keith Hamasaki, CPA Director Assurance & Advisory

360° Service Model •

Advisory and Consulting Services •

Internal Control Review and Accounting Process

•

Cybersecurity Risk Assessment

•

Accounting

•

Mergers & Acquisitions

Implementation

Evelyn Fernandez, CPA, MST

•

Director - Tax •

Phil Clark, CFP® Director - KROST Wealth Securities offered through Avantax Investment ServicesSM, Member FINRA, SIPC. Investment advisory services offered through Avantax Advisory Services SM. Placing business through Avantax Insurance Services SM CA#0M36260.

Compliance Services •

Audits, Reviews, and Compilations

•

Tax Preparation

Tax Planning Services •

Tax Consulting

•

Research and Development Tax Credits

Experience You Can Trust Our Sector Expertise •

Aerospace & Defense

•

Automotive & Transportation

•

Consumer Products

•

Food & Beverage

•

Industrial Parts

•

Recreational and Wellness Products

•

Wholesale Distribution

•

And more...

“The experienced, multi-disciplined teams at KROST can provide tax, accounting, and consulting services for manufacturing industry-specific needs, as well as a holistic approach to tackling multiple challenges as a true partner in the development of your business.”

KROST QUARTERLY VOL. 3 ISSUE 2 - THE MANUFACTURING ISSUE

ACCOUNTING FOR PPP LOANS AND FORGIVENESS By Keith Hamasaki, CPA Director - Assurance & Advisory

he Coronavirus Aid, Relief, and Economic Security (CARES) Act was signed by President Trump to help keep small businesses afloat amid the mandated COVID-19 related closures. The CARES Act included a Paycheck Protection Program (PPP), which initially authorized up to $349 billion of federally guaranteed loans to qualified small businesses. That amount was subsequently increased to $659 billion. The PPP loan gave businesses access to capital when other liquidity and financing options were unavailable. An enormous benefit to the PPP loan is that it may be forgiven if the borrower spends the proceeds on eligible expenses, meets certain other criteria, and applies for forgiveness. Unforgiven amounts turn into two or five year loans at 1% annual interest rate. As a debt instrument that has characteristics of debt and a government

KROST PPP BUDGETING AND FORGIVENESS MAXIMIZATION TOOL The PPP Budgeting and Forgiveness Maximization Tool allows you to budget and plan the use of PPP loan proceeds, on a month-by-month basis, to maximize forgiveness. This includes detailed staff planning, minimizing loan forgiveness reductions, and ensuring non-payroll related costs remain within the allotted 40%. Actual expenditure can also be tracked, and the tool gives you a monthly actual vs. budget report. This product is available for purchase on our website at: KROSTCPAs.com/product/ppp-budgeting-and-forgiveness-maximization-tool

grant, businesses should take considerable care and carefully adhere to the criteria requirements. These criteria requirements include maintaining accurate details for their accounting records. The KROST PPP Budgeting and Forgiveness Maximization Tool helps businesses appropriately account for these transactions and maximize their PPP loan forgiveness.

In June 2020, the AICPA issued guidance on the appropriate accounting for PPP loans and forgiveness of these loans. 4

KROST QUARTERLY VOL. 3 ISSUE 2 - THE MANUFACTURING ISSUE

ACCOUNTING FOR PPP – INITIAL RECOGNITION It is appropriate to treat the PPP as debt in accordance with Accounting Standards Codification (“ASC”) 470. However, there is guidance for nonprofit entities that may be applied under ASC 958-605 as a refundable advance. Let’s explore the specific journal entries and their effect on financial statements. To make it easier to track, we recommend recording the PPP loan as a separate line item. The PPP loan should be initially accounted for as a liability because the two criteria of ASC 405 that (1) the debtor pays off the loan to the creditor, or (2) the debtor has been legally released, have not yet been met. In our example, a manufacturing company that develops and manufactures robotic parts receives a $1,500,000 PPP loan.

Step 1 Debit Cash

Credit

1,500,00

Liability (either Note Payable, PPP or Refundable Advance PPP)

1,500,000

Illustrated below: DEBT

Unadjusted 2020

Assets

Adjusted 2020

Adjustment

(extracted)

Current Assets Cash

Accounts receivable Total assets

+1,500,000

XXXXXXXXXX $

XXXXXXXXXX

XXXXXXXXXX Unadjusted 2020

Liabilities

1,500,000

XXXXXXXXXX Adjusted 2020

Adjustment

(extracted liabilities and ignores classified balance sheet)

Accounts payable

Accrued interest Line of credit borrowings Note payable, Paycheck Protection Program

XXXXXXXXXX

XXXXXXXXXX +1,500,000

1,500,000

XXXXXXXXXX $

XXXXXXXXXX

Note payable, related party Total liabilities

XXXXXXXXXX

XXXXXXXXXX $

XXXXXXXXXX

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ACCOUNTING FOR PPP – RECORDING INTEREST At each period end, interest should be accrued. Interest begins to accrue in accordance with the terms of the loan, or generally at the inception of the loan. ASC 835-30 precludes imputed interest beyond 1% because it is a loan from a governmental entity.

Step 2 Debit Interest expense

Credit

3,750

Liability (accrued interest)

3,750

Illustrated below: DEBT

Unadjusted 2020

Liabilities

Adjusted 2020

Adjustment

(extracted liabilities and ignores classified balance sheet)

Accounts payable

XXXXXXXXXX

Accrued interest

XXXXXXXXXX

Line of credit borrowings

XXXXXXXXXX

1,500,000

XXXXXXXXXX

Note payable, Paycheck Protection Program Note payable, related party Total liabilities

+3,750

XXXXXXXXXX

3,750

XXXXXXXXXX

CERTIFYING PPP Companies that receive the PPP loan must certify, in good faith, that the need for funds was related to COVID-19 and that the funds will be used for certain expenses (i.e., payroll, utilities, etc). Companies that exceed $2 million and above in funding will be reviewed by the SBA for compliance of their good faith certification. Upon legal release of debt obligations, companies may record the debt forgiveness.

Discover how KROST can help with your good faith certification.

ACCOUNTING FOR PPP – FORGIVENESS The portion of the PPP loan that is forgiven must meet the criteria set forth in ASC 405-20. PPP loan forgiveness is determined by the following criteria: (1) The loan is, in part or wholly, forgiven, and the debtor has been “legally released;” OR (2) The debtor pays off the loan to the creditor. In our example, we assume that the Company meets the criteria of being legally released. 6

KROST QUARTERLY VOL. 3 ISSUE 2 - THE MANUFACTURING ISSUE

Step 3 Debit Note payable, Paycheck Protection Program

Credit

1,500,000

Gain on forgiveness of PPP extinguishment

1,500,000

Liability (accrued interest)

3,750

Gain on forgiveness of PPP extinguishment

3,750

Illustrated below: DEBT

Liabilities

Unadjusted 2020

Adjusted 2020

Adjustment

(extracted liabilities and ignores classified balance sheet)

Accounts payable

Accrued interest

3,750

Line of credit borrowings

1,500,000

Note payable, related party

XXXXXXXXXX

-1,500,000

XXXXXXXXXX $

Statement of income

XXXXXXXXXX

XXXXXXXXXX Unadjusted 2020

XXXXXXXXXX

-3,750

XXXXXXXXXX

Note payable, Paycheck Protection Program

Total liabilities

XXXXXXXXXX

XXXXXXXXXX Adjusted 2020

Adjustment

(extracted)

Other income (expense): Gain on forgiveness of PPP extinguishment

Total other income (expense)

Net income

1,503,750

XXXXXXXXXX

The tax ramifications for debt forgiveness is treated differently from accounting in accordance with GAAP, please contact one of our tax professionals to gather additional information. Companies need to know how to properly account for the PPP to ensure accurate financial records that meet lending requirements. Proper accounting of the PPP will maximize forgiveness, while maintaining financial records to meet loan covenants. At KROST, we translate the complex into easily understandable ideas so that our clients can make informed decisions. We’ve created a COVID-19 Resource Center with the latest news, quick links to various state and federal websites, and several other tools to help businesses and individuals navigate the pandemic. 

CONTACT KEITH 

KROST QUARTERLY VOL. 3 ISSUE 2 - THE MANUFACTURING ISSUE

MANUFACTURERS WITH INTERNATIONAL OPERATIONS SHOULD EXPECT A TAX BILL -

PANDEMIC OR NOT By Guest Contributor, Alex Martin KBKG Tax Credits, Incentives, & Cost Recovery

Governments with pressing needs for revenue will target multinationals. Here’s how to mitigate the risk.

ccording to the Center for Budget and Policy Priorities, individual income taxes generate approximately 50 percent of US federal government revenue.1 With unemployment rates now above Great Recession levels, individual taxes, along with most other streams of revenue, will fall well short of years past. For manufacturers with international operations, audits of cross-border pricing are a prime opportunity to replace some of the revenue lost to the pandemic.

Question: How will tax authorities target manufacturers? Answer: Are you paying tax overseas? With government budgets already stretched, generating additional tax from multinational companies is an attractive option. We expect that subsidiaries of manufacturers will be one of the first targets for closing the budget gap. In essence, manufacturers will be accused of shifting profits through incorrect transfer prices – even if there are no profits. Why? Tax auditors will argue that parent companies should bear all of the risks of a downturn in the market, regardless of a pandemic. Auditing the transfer prices of a local subsidiary is a relatively straightforward strategy with a high return on government investment. In essence, the subsidiary manufacturing plant or distribution operation should be “insulated” through lower intercompany prices of goods, royalties, and services. Targeting subsidiaries is also straightforward: how much income tax has a subsidiary paid?

KROST QUARTERLY VOL. 3 ISSUE 2 - THE MANUFACTURING ISSUE

“WE EXPECT THAT SUBSIDIARIES OF MANUFACTURERS WILL BE ONE OF THE FIRST TARGETS FOR CLOSING THE BUDGET GAP.”

WHO IS MOST AT RISK? 1. Manufacturing and distribution subsidiaries with a history of losses, even before COVID. Tax authorities can make transfer pricing adjustments and issue penalties for all open tax years. A subsidiary company that fails to earn profits during normal market conditions is, at first glance, a transfer pricing problem. From a theoretical perspective, would an independent company that consistently loses money continue to transact with a manufacturer at existing prices?

INSIGHT • • •

A best practice for assessing risks is to review Earnings Before Interest and Tax (EBIT) as a percentage of sales for all open tax years in each overseas jurisdiction. Subsidiaries with a history of steady profit margins are better placed to argue that current year losses are commercial rather than a transfer pricing problem. For some manufacturers, changing transfer prices to variable costs plus a margin policy may be a wise move to reduce losses overseas.

2. Companies that have rigid transfer pricing policies. Transfer pricing policies are useful for reducing the administrative burden of negotiating prices between related companies. However, the outdated "cost plus ten percent" standard may no longer lead to accurate results. Arguments that “we have always done it this way” are challenging to sustain. Moreover, a transfer pricing policy that generates taxable profits at the parent company, but has significant losses overseas often leads to a suboptimal tax result. For multinational companies, revisiting transfer pricing policies should be high on the agenda for 2020. 3. Companies that cannot demonstrate that subsidiary losses are commercial rather than incorrect transfer prices. Once 2020 tax audits commence, every auditor will be well-aware of the argument that COVID-19 depressed revenues, and therefore losses are not transfer pricing related. A typical response to that argument is that “parent companies have greater access to the financial resources during a downturn.”

In our experience, quantifying losses by comparison to a normal business cycle is more convincing to an auditor. An economic analysis prepared as part of transfer pricing documentation is helpful in this situation, but management estimates of COVID-19 losses prepared during 2020 could be just as compelling. A company analysis prepared as part of the normal course of business can help demonstrate how much of a loss is due to abnormal business conditions.

INSIGHT •

•

Contemporaneous transfer pricing documentation is more persuasive than a hastily prepared analysis compiled in response to an audit. Collecting evidence that third-party suppliers or customers share the risk of losses in a downturn is extraordinarily helpful (e.g., contracts).

FOR U.S. COMPANIES – LOOK AT THE CARES ACT FOR SAVINGS Under the Coronavirus Aid, Relief, and Economic Security (CARES) Act, U.S. corporations can now elect to carry back losses incurred in 2020 for a five-year period (2015 to 2019). Before the CARES Act, US corporations could not carry back losses as a result of US tax reform. Companies that have tax Net Operating Losses (NOLs) in the US during 2020 now have the opportunity to carry back losses against income previously taxed. The cash savings can be as high as 35 percent when electing to apply tax NOLs for profits earned in years before US tax reform.

INSIGHT •

Some US manufacturers may benefit from transfer pricing planning by incurring more losses in the US versus other countries. The CARES Act may offer another potential avenue to apply for refunds from income previously taxed.

Manufacturers may be surprised by a tax audit shortly after surviving a pandemic. However, governments globally are hungry for revenues, and losses incurred by subsidiary companies are red flags for tax auditors. By taking some proactive steps now, manufacturers with international operations may be able to save some cash and persuade an auditor to look elsewhere for revenue. 

LEARN MORE 

1 https://www.cbpp.org/research/federal-tax/policy-basics-where-do-federal-tax-revenues-come-from

KROST QUARTERLY VOL. 3 ISSUE 2 - THE MANUFACTURING ISSUE

CORONAVIRUS RESOURCE CENTER Webinars

PPP Budgeting and Forgiveness Maximization Tool

Up-to-Date Articles

Tax Resources

We have created a COVID-19 resource center with tools and resources to help individuals and businesses impacted by the Coronavirus. Please visit KROSTCPAs.com/covid-19-resource-center to learn more.

FOREIGN-DERIVED INTANGIBLE INCOME (FDII) CAN INCREASE CASH FLOW FOR MANUFACTURING COMPANIES AND DISTRIBUTORS WITH GLOBAL OPERATIONS By Evelyn Fernandez, CPA, MST | Director - Tax

he Tax Cuts and Jobs Act (TCJA) included several tax changes relating to the US taxation of multi-national companies. One change that specifically impacts manufacturers and distributors with global operations is the implementation of the Foreign-Derived Intangible Income (FDII) deduction (IRS Section 250).

The calculation of FDII is complex, but the bottom line is that it offers a 37.5% deduction to US C corporations on qualifying activity. This reduces the 21% corporate tax rate to 13.125% for tax years beginning after December 31, 2017, and before January 1, 2026. After this date, the deduction drops down to 21.875%, which results in an effective corporate tax rate of 16.406%.

The three key items to note about the deduction are: 1. Only US C corporations qualify. 2. There must be foreign-derived deduction eligible income. Income that falls into this category includes foreignderived sales of products or services provided. •

•

Foreign Derived Sales - Property sold to a foreign person for foreign use. One crucial point is that the product does not need to be manufactured in the United States to qualify. The key is that the consumption/ usage occurs outside of the United States. Also, if a product is sold to a foreigner who then further manufactures/alters the product in the US, it won’t qualify as eligible income. Foreign Derived Services - Services provided to individuals/entities who are outside the United States. An example of this would be a US architectural firm that designs buildings for a homebuilder company in Canada. Another example is a software developer who develops software for a company in the UK. There are related party service rules that should be carefully examined. Services do qualify if provided to a related party, if that party is located outside of the US, and also if they do not offer a similar service as the US company.

3. The corporation must be profitable. FDII cannot be larger than the company’s taxable income. The deduction is further limited to Qualified Business Asset Investment (QBAI), which is the tax basis of depreciable assets using the Alternative Depreciation System (ADS) method.

KROST QUARTERLY VOL. 3 ISSUE 2 - THE MANUFACTURING ISSUE

“ONE CRUCIAL POINT IS THAT THE PRODUCT DOES NOT NEED TO BE MANUFACTURED IN THE UNITED STATES TO QUALIFY.”

Some planning opportunities involved in increasing the amount of FDII deduction available are: •

Increase foreign-derived receipts. If the company hasn’t thought about or hasn’t tried offering products or services outside of the US, now is a good time to evaluate this decision.

•

Increase QBAI base. The higher the depreciable tangible property used to produce the eligible income, the higher the deduction.

•

Allocation of expenses. Cost of goods sold should be re-examined to make sure the proper amount is being apportioned to domestic and foreign-derived income.

Beginning in tax years after 2019, there will be strict documentation rules to satisfy requirements, and the calculations can be quite complex. However, with careful planning, FDII can drastically increase cash flow for US companies who are involved with export transactions or provide services for foreign use.  CONTACT EVELYN 

KROST QUARTERLY VOL. 3 ISSUE 2 - THE MANUFACTURING ISSUE

INNOVATION, POSITIVITY, AND EVOLUTION:

HOW THREE BUSINESSES ARE NAVIGATING THE PANDEMIC

or insight into how manufacturers and businesses that rely heavily upon supply chains have been impacted by COVID19, we connected with a few of our clients to hear about their experiences over the last several months. We interviewed Bobby Serrano of Serrano Industries, Inc., a locally owned and operated computer numerical control (CNC) machine shop that produces products for defense, aerospace, and space programs; Chris Long of Drop Labs, a shoe company that relies heavily on an international supply chain, to produce a unique Bluetooth-enabled shoe that delivers ground vibration sensations; and Richard Bergrin of LumaForge, a supplier of custom computer servers that relies on American supply chains for their parts and assembly. From shutdowns and furloughs to innovations and opportunities, here is what we learned.

DEALING WITH COVID-19 Not surprisingly, our clients experienced a range of financial and sometimes emotional blows during the governmentmandated shutdowns because of the pandemic. LumaForge’s customer pipeline has been in a state of hibernation, as many businesses put off buying servers and cut expenses. Serrano Industries has pushed orders out to 2021-2022 nearly across the board. Additionally, aerospace makes up 40% of its current business. That industry suffered immensely due to canceled flights and travel, which in turn impacted Serrano Industries, as they produce custom parts such as airline food trays. Drop Labs had to furlough staff and cut salaries of all employees on payroll by 30-70% to survive the period. The furloughs and pay cuts to their valuable team members took a toll.

POSITIVE IMPACTS AND INNOVATIONS Pictured: Serrano Industries, Inc. 14

KROST QUARTERLY VOL. 3 ISSUE 2 - THE MANUFACTURING ISSUE

Not all hope was lost during this period, as each of these

businesses found ways to innovate and pivot their business model to create opportunities. Drop Labs used the time to perfect their product. They performed research and development on the footplates and attachment of the transducers in the shoes. They were able to incorporate the new improvements into their latest release. LumaForge developed software that allows for remote access to on-premise servers. Not only did this help their business, but it also allowed many of their customers to continue to work remotely. Serrano Industries launched two new robots in their facility, which created more efficiency while saving money for customers. They also decided to diversify their customer base further, adding to the industries they serve.

Pictured: Drop Labs

GOVERNMENT RELIEF PROGRAMS FOR MANUFACTURERS To aid in relief, the government has backed several programs available to manufacturers and businesses alike. Loans such as the EIDL, PPP, and Main Street have allowed borrowers to keep employees on payroll and pay for expenses. Additionally, there is the Employee Retention Credit, which offers up to $5,000 per employee, as well as Payroll Tax Deferment, among others. KROST’s clients across all industries have taken advantage of the funds available.

has really given us peace of mind because they pretty much handled everything with our bank relationship manager to help expedite the whole process. Now that we have the PPP, KROST has created a worksheet to help apply for the forgiveness, and this really streamlined everything and got us ahead of the curve,” remarked Bobby Serrano, Serrano Industries.

“KROST ASSISTED US DURING THE PANDEMIC WITH THE PPP, WHICH HAS REALLY GIVEN US PEACE OF MIND BECAUSE THEY PRETTY MUCH HANDLED EVERYTHING WITH OUR BANK RELATIONSHIP MANAGER TO HELP EXPEDITE THE WHOLE PROCESS.” Richard Bergrin, VP of Finance and Accounting at LumaForge, secured the PPP loan with some guidance from KROST through the process. Drop Labs CFO Chris Long secured a PPP loan, but also took advantage of the Payroll Tax Deferral, and continued to take R&D Tax Credits, as they had done since 2017. All of which provided much needed cashflow during the crisis. President of Serrano Industries, Bobby Serrano, relied heavily upon KROST to relieve their company of the burden of applying and managing the PPP loan application process. “KROST assisted us during the pandemic with the PPP, which

All of the companies expressed overwhelming relief that the loans were approved and that their companies could benefit. Drop Labs was able to bring back all furloughed staff immediately after securing their loan. “Throughout this process, KROST has been so helpful. Everyone is happy to answer my questions. The team is up to speed with the issues we are facing with the PPP, and overall, they made the process much smoother for us,” said Chris Long, Drop Labs.

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LOOKING TOWARD THE FUTURE When asked what they thought the future would hold for the manufacturing industry and their company, each of the companies reflected upon a need for less rigidity in the workplace, more innovation, and a diversified customer base. “We are going to have a mind and an eye toward flexibility and breaking down the rigidity of pre-COVID office work. Certainly, in office design, development – you want access to work portably (from home or elsewhere). For LumaForge, it is about runway and cash liquidity, to ensure that when things slow down, we can survive. Layoffs are not the only way to get through hard times, especially when they are expected to be temporary. We were fortunate to have had no layoffs and only temporary furloughs, as we went into survival mode,” remarked Richard Bergrin, LumaForge. Drop Labs looked toward new manufacturing facilities in other countries and plans to continue this search as time goes on. “Before this happened, we were looking into alternative locations for manufacturing. It’s a difficult process (the development of the product), the supply chain needs to be trained well, or the product will not work. Everything was going well with China up until this experience, but now we are really looking into alternative suppliers in other countries,” said “THROUGHOUT THIS PROCESS, Chris Long, Drop Labs.

KROST HAS BEEN SO HELPFUL. EVERYONE IS HAPPY TO ANSWER MY QUESTIONS. THE TEAM IS UP TO SPEED WITH THE ISSUES WE ARE FACING WITH THE PPP...”

Serrano Industries plans to increase automation with more technology to produce the same revenue with less human resources. While they have served a wide range of industries, they also hope to further diversify their customer base to medical and R&D in the future.

FINAL THOUGHTS

Navigating the complexities of this trying time has challenged each of our clients to adapt to this new normal. The resounding message we heard during our time with Bobby, Richard, and Chris, was how they encourage everyone to remain positive and take advantage of any and all federal programs that one can. They feel grateful for their situations, as well as the unique, and unexpected, opportunities that have arisen out of the pandemic. It is all of our hope that we, as individuals and as a nation, come out on the other side of this stronger. A big thank you to Bobby, Richard, and Chris for their candid conversations with us. We hope you continue to thrive throughout this time and beyond, and above all, stay safe.  » Learn more about Serrano Industries, Inc. » Learn more about Drop Labs » Learn more about LumaForge

Pictured: LumaForge 16

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EMPLOYEE RETENTION CREDIT (ERC) PROVIDES BENEFITS FOR MANUFACTURING EMPLOYERS By Jim Estrella, CPA, MSA Senior - Assurance & Advisory

or manufacturers who experienced a suspension in operations or decline in business compared to 2019 due to the COVID-19 crisis, the Employee Retention Credit (ERC) may be a welcome relief. Under the CARES Act, the ERC offers a significant credit back for qualified wages, just for keeping employees on the payroll. This and other government relief programs have helped manufacturers survive this economic downturn with many facilities closed due to government orders.

WHO QUALIFIES? Eligible manufacturers must meet one of the following criteria: 1. Have operations fully or partially suspended; •

If government authorities impose restrictions on operations limiting commerce, travel, or group meetings;

•

Can include facilities with multiple locations with varying closure guidelines.

2. Experience a significant decline in gross receipts during a calendar quarter; •

If an employer’s gross receipts are less than 50% of its gross receipts for the same calendar quarter in 2019;

•

Gross receipts include any income from investments and incidental or outside sources.

The credit is available to all employers regardless of size, including tax-exempt organizations.

QUALIFIED WAGES Eligible, qualified wages include all compensation paid by an eligible employer, including health plan expenses paid during the credit period. KROST QUARTERLY VOL. 3 ISSUE 2 - THE MANUFACTURING ISSUE

The credit period is dependent on the eligibility test the employer must meet to qualify as an eligible employer. If the employer qualifies under the full or partial suspended operations test, the credit period will be the period of time the employer has operations suspended. If the employer qualifies under the significant decline test, the credit period starts with the first calendar quarter in 2020 with gross receipts less than 50% of the same calendar quarter in 2019. It ends on the last day of the first calendar quarter with gross receipts being 80% or more of the gross receipts of the same calendar quarter in 2019. The credit period cannot begin earlier than March 13, 2020, and must end by December 31, 2020.

Qualified wages and health care costs are defined differently, depending on the size of the employer. 100 or less employees: •

All qualified wages paid to employees during the determined period (including health care costs).

More than 100 employees: •

Qualified wages paid to employees for the time the employee DID NOT work due to economic hardship as a result of COVID-19 (does not include PTO or vacation time earned under the existing compensation structure);

•

Plus, healthcare costs prorated to the time the employee did not provide services to the company.

HOW MUCH IS IT WORTH? The credit is computed at a rate of 50% of qualified wages and health care costs paid up to a maximum of $10,000 of costs. This results in a maximum credit of $5,000 per eligible employee. Beginning with the 2nd quarter, manufacturers can get immediate access to the credit by reducing employment tax deposits that are otherwise required.

Case Study:

Employer with more than 100 employees An employee works only two days but is paid their normal schedule (5 days). $20/hr x 40 hours = $800 weekly wages + $200 health care benefits (weekly) = $1,000 total weekly cost paid by the employer. The Company is receiving benefits for 40% of the time paid (2 days/5 days) and is not receiving services for 60% of the wages paid, so the employer can claim a credit on 60% of the wages and health costs paid. With a weekly cost of $1,000 between wages and health care multiplied by 60%, the total equals $600 in costs that qualify for the credit. $600 multiplied by the credit rate of 50% results in a credit of $300. If we apply this same scenario to the entire year with the same assumptions with a weekly payroll, the 2nd quarter would have 13 pay periods multiplied by the $300 credit, resulting in a total 2nd quarter credit of $3,900. The credit would max out in the 3rd quarter after four weeks resulting in a capped 3rd quarter credit of $1,100. In this case, the max credit is reached in 17 weeks. Assuming a total of 100 employees at the same rate, the calculations would result in:

Total = $500,000 credit

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CONSIDERATIONS •

Manufacturers who have applied for and accepted a PPP loan do not qualify for the ERC (unless the PPP was returned by May 18, 2020).

•

Affiliation and aggregation rules do apply to ERC. Each employer must apply the aggregation rules of IRC 414(m) and (o), as well as IRC section 52(a) or (b).

•

The ERC can be claimed with other programs such as the Main Street Loan Programs, Medical Leave Credit, and others.

GET THE CREDIT

“THE CREDIT IS AVAILABLE TO ALL EMPLOYERS REGARDLESS OF SIZE, INCLUDING TAX-EXEMPT ORGANIZATIONS.”

KROST can help calculate qualified wages and determine benefits for manufacturers. We have come up with a detailed computation for reporting and tracking qualified wages (salary and hourly), healthcare costs, furloughed wages, and other costs. To estimate benefits, try KROST’s PPP Budgeting and Forgiveness Maximization Tool. Manufacturers must report qualified wages on IRS From 941 to obtain credits. Qualified employers can request an advance of the credit by submitting IRS Form 7200. 

LEARN MORE 

KROST QUARTERLY VOL. 3 ISSUE 2 - THE MANUFACTURING ISSUE

MANUFACTURING COMPANIES BEWARE:

CCPA MAY IMPACT YOUR BUSINESS By Keith Hamasaki, CPA | Director - Assurance & Advisory

he California Consumer Privacy Act (“CCPA”) is a comprehensive framework to protect California residents (consumers). Effective January 1, 2020, data protection became a California requirement for businesses. All businesses that meet certain criteria are required by law to protect consumer data or face fines or penalties beginning July 1, 2020. As of this writing, enforcement of the CCPA will not be delayed, even as companies face COVID-19 and telecommuting challenges. The final proposed regulations package was submitted on June 1, 2020, to the California Office of Administrative Law, outlining enforcement and assessing penalties for noncompliance. Covered businesses that must meet security compliance or fulfill consumer privacy requests for removing non-sharing data under CCPA should first determine whether they hold personal information of California residents. Most manufacturing companies immediately dismiss this because they sell to a distributor and generally not direct to the consumer. However, with advances in technology, manufacturing companies may inadvertently hold personal data. Such examples of personal data are (1) warranties that identify the person who holds the product, (2) payment card industry data (PCI), (3) personal health information maintained in medical devices, (4) information collected from various Internet of Things (IoT), or (5) automotive products that transmit data back to the manufacturer.

KROST QUARTERLY VOL. 3 ISSUE 2 - THE MANUFACTURING ISSUE

“COVERED BUSINESSES THAT MUST MEET SECURITY COMPLIANCE OR FULFILL CONSUMER PRIVACY REQUESTS FOR REMOVING NONSHARING DATA UNDER CCPA SHOULD FIRST DETERMINE WHETHER THEY HOLD PERSONAL INFORMATION OF CALIFORNIA RESIDENTS.”

Businesses that meet one of the following criteria will be subject to CCPA: 1. Has gross annual revenue in excess of $25 million; 2. Buys, receives, or sells the personal information of 50,000 or more consumers, households, or devices; 3. Derives 50% or more of annual revenue from selling or sharing consumers’ personal information. The State of California Department of Justice will assess violations ($7,500 per intentional violation and $2,500 per unintentional violation, data breaches of up to $750 per consumer incident) for noncompliance with the CCPA beginning July 1, 2020 that will retroactively apply to January 1, 2020, and violations will result in significant consequences. Businesses are held accountable for any breach of consumer privacy rights, and the penalties are higher when the violation affects children. In addition to monetary penalties, businesses that fail to protect consumer personal information could suffer brand damages. The assessment, development, and implementation of processes to comply with the CCPA can be a daunting task. So, where do companies begin? KROST’s cybersecurity experts have developed a dedicated CCPA framework and cybersecurity risk assessment to take out the guesswork. This process helps the business meet the standard that it has implemented good faith efforts to comply with CCPA. Additionally, it includes a thorough review of privacy policies and internal controls to ensure compliance, complete with a checklist of requirements that need to be addressed as soon as possible to mitigate fees and penalties from violations. Have questions about CCPA? We’re here to help. Contact us today.  This has been prepared for information purposes and general guidance only and does not constitute legal or professional advice. Neither KROST nor its personnel provide legal advice to third parties. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and KROST, its members, employees, and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.

CONTACT KEITH 

KROST QUARTERLY VOL. 3 ISSUE 2 - THE MANUFACTURING ISSUE

RELIEF COMES IN THE FORM OF

R&D TAX CREDITS

FOR MANUFACTURING COMPANIES By Guest Contributor Michael Maroney KBKG Tax Credits, Incentives, & Cost Recovery

s history has shown us, difficult times can spark a renaissance of innovation and creativity. With the continued impact of the Coronavirus on American businesses, many companies are rolling up their sleeves, pivoting their focus, and offering radical solutions to solve our pandemic problems. Retooling production lines is just one way manufacturers have shifted their focus to help those in need, keep employees on the payroll, and remain productive and profitable during this crisis. Here are a few examples: •

A Seattle-based company, Tom Bihn, transformed their factory to develop cloth face masks.

•

A 3D-printing lamp company, Gantri, repurposed its facility to produce 3D-printed visor frames for health care workers.

•

EverlyWell has developed an at-home COVID-19 test kit.

It is not just large manufacturers and Silicon Valley giants who are spearheading this transition, many small to mid-size businesses are performing miracles as well. These companies include pharmaceutical, clothing, technology, cosmetics, textile, and others. Whether a company is contributing to relief efforts or trying to maintain business or retain its employees, Research & Development (R&D) Tax Credits can offer much-needed cashflow. R&D tax credits provide a dollar-for-dollar reduction in federal and state tax liability, and unused credits can be carried back to the prior year, then forward for up to 20 years. Companies can get a tax refund for the credits claimed on amended returns, and all open tax years are available to amend (three years for federal and up to four years for some states). 22

KROST QUARTERLY VOL. 3 ISSUE 2 - THE MANUFACTURING ISSUE

“RESEARCH & DEVELOPMENT (R&D) TAX CREDITS CAN OFFER MUCH-NEEDED CASHFLOW.”

Companies that invest in capital projects, such as expanding production facilities or making significant changes to a production line to produce a new item, can capture the qualified time and expense associated with that project towards the credit. Process improvements intending to improve efficiency, reduce energy consumption, increase capacity, improve quality, reduce waste, or automate manual tasks through software development or robotics may also qualify. The additional cash flow generated from these credits can be significant. Companies can pay off debt, secure much-needed financing, make payroll, hire engineers, purchase equipment, and launch a new product. Most states offer an R&D credit incentive for qualified research taking place within the state for an added benefit. To qualify for the credit, companies must be performing qualified research, which includes all the following: 1. Conducting activities that are technological in nature, relying fundamentally on a hard science (e.g., physics, biology, engineering, or computer science); 2. The activities must intend to result in a new or improved product or process; 3. The research must contain technical uncertainty as to the capability, appropriate design, or appropriate method; AND 4. The research must follow a process of experimentation, whereby alternative materials, designs, processes, methods, or techniques are evaluated to arrive at an optimal solution. To the extent a company’s activities meet this “Four-Part Test,” the following expenses can be claimed toward the credit: 1. Employee wages dedicated to qualified research activities; 2. Prototype supplies used in the design; and 3. Third-party contractor expenses paid for qualified research. The credit is equal to roughly 10% of these qualified expenses. The federal credit is now permanent, so companies can be confident in claiming these credits for many years to come. If your company made significant process improvements during the past few years, whether in response to COVID-19 or simply to gain a competitive advantage, the R&D tax credits can be a source of cash during these uncertain times.  LEARN MORE 

https://www.wired.com/story/covid-19-charities-nonprofits-companies-helping/

KROST QUARTERLY VOL. 3 ISSUE 2 - THE MANUFACTURING ISSUE

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KROST QUARTERLY MAGAZINE

For over 80 years, KROST has assisted businesses and individuals reach their financial goals through an in-depth knowledge in Tax, Accounting, Assurance and Advisory, M&A, and Wealth Management Services. KROST also provides specialty tax services such as Cost Segregation Studies, R&D Tax Credits, Transfer Pricing, Green Building Tax Incentives, Repair vs. Capitalization, Fixed Asset, IC-DISC, and more.

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