Optimizing Tax Credits for Manufacturing Companies
By Ted Lucas, Partner, Assurance Services & Cassie Carangelo, Supervisor, Assurance Services
As the year 2021 dawns, companies in the manufacturing space are at the center of innovation and growth. Manufacturing companies are increasingly leading the way by developing new products or new processes to produce products. Innovation requires research, which stimulates job growth and capital investment. Due to its positive economic impact, Congress and 36 state governments incentivize research to be performed within the U.S., offering tax credits which may offset tax liability and in some cases generate refund opportunities.
The Research and Development (R&D) Credit and the Work Opportunity Tax Credit (WOTC) are two excellent tax planning opportunities for businesses to substantially reduce tax liability. For what amounts to regular business activity, manufacturing companies can qualify for federal and state tax savings to allow them to hire new employees, invest in new products and service lines, and grow existing operations.
FEDERAL AND STATE RESEARCH AND DEVELOPMENT TAX CREDIT
The federal R&D credit was created in 1981 to keep technical jobs in the U.S. by rewarding companies for conducting R&D domestically. The credit is fairly robust as it applies to businesses of all sizes, not limited to major corporations with research labs. Many states have significant credits opportunities too that follow federal in qualifying activities but have unique computational and application methodologies.
The research credit applies to a broad range of manufacturing activities. If a company does any of the following, it likely qualifies for the R&D credit:
- Development/design of new products or processes;
- Development/design of new manufacturing processes;
- Enhancement of existing products or processes;
- Development of prototypes or pilot processes;
- Performing environmental testing;
- New product manufacturing trials;
- Development of technology to comply with regulatory agencies; and
- Core R&D direct support activities
In order to claim the credit, a manufacturer must contemporaneously document its research activities to establish the amount of qualified research expenses paid for each qualified research activity. It is permissible to estimate some expenses, but taxpayers must have a factual basis for the assumptions used to create the estimates. Some examples of pertinent documentation:
- Payroll records;
- General ledger expense details;
- Project lists; and
- Project notes
For most companies that are aware of the R&D tax credit, the calculations are prepared with tax compliance filings on an annual basis.
For those companies that have never applied for the R&D tax credit in the past, the credit allows for companies to amend their tax filings to capture the previous three years of activity. For this reason, first time applicants stand to generate a large credit that can carryforward 20 years or a substantial refund depending on previously paid taxes.
FEDERAL RESEARCH AND DEVELOPMENT TAX CREDIT – PAYROLL TAX CREDIT
The Protecting Americans from Tax Hikes Act of 2015 (The PATH Act) permanently extended many expiring tax laws, including the R&D credit. The PATH Act allows startup businesses with no federal tax liability and gross receipts of less than $5 million to take the R&D tax credit against their payroll taxes (employer paid FICA – 6.2%) for tax years beginning in 2016, essentially making it a refundable credit capped at $250,000 for up to five years.
In order to be eligible to offset the FICA portion of payroll tax, companies must meet the definition of a qualified small business (QSB). The election to offset payroll taxes must be made on a timely filed income tax or informational return, including extensions. In the case of a QSB that is a partnership or S corporation, the election must be made at the entity level. For corporations and partnerships, the gross receipts and the credit limitation apply on a controlled group basis.
What is a Qualified small business (QSB)?
- Less than $5 million in annual gross receipts
- Companies formed in or after 2017
WORK OPPORTUNITY TAX CREDIT (WOTC)
First introduced in 1996, the Work Opportunity Tax Credit (WOTC) is a workforce program that incentivizes workplace diversity by making a tax credit available to employers that hire individuals from groups who have faced significant barriers to employment. By utilizing the WOTC, employers are not only rewarded for every new hire who meets the eligibility requirements, but also, create a positive impact on the nation’s unemployment levels.
The WOTC is based on qualified first-year wages for members of certain targeted groups and is generally equal to 40% of the first $6,000 of wages, for a maximum credit of $2,400 per employee. The ten target groups that qualify for WOTC include:
- Qualified IV-A recipients
- Qualified Veterans
- Designated Community Residents (DCR)
- Vocational rehabilitation referrals
- Summer youth employees
- Supplemental Nutrition Assistance Program (SNAP) recipients
- Supplemental Social Security Income (SSI) recipients
- Long-term family assistance recipients
- Qualified long-term unemployment recipients (added when the PATH Act took effect)
The WOTC for certain target groups provides an even greater tax incentive than the general maximum credit of $2,400 per employee. For example, The WOTC for long-term family assistance recipients equals 40% of qualified first-year wages paid, up to a maximum of $10,000 per employee (maximum credit of $4,000) and 50% of qualified second-year wages paid, up to a maximum of $10,000 per employee (maximum credit of $5,000). Additionally, for several categories of qualified veterans, more than $6,000 of first-year wages are eligible for the credit. The increased wage amounts for qualified veterans range from $12,000 to $24,000 per employee.
Similar to other tax credits and incentives, specific requirements must be met before an employer is eligible for the WOTC. The important thing to remember for the WOTC is that the required forms and application must be submitted within 28 calendar days of the employee’s start date. Once the state agency determines that the individual meets the requirements and certifies the application, the employer may claim the WOTC as part of the General Business Credit.
What are the requirements?
- Certification and verification of a job applicant’s status as a qualifying member
- Submit IRS Form 8850 together with ETA Form 9061 or ETA Form 9062 to your state’s workforce agency
The WOTC was previously set to expire at the end of 2020. However, the Taxpayer Certainty and Disaster Tax Relief Act of 2020, which was enacted as part of the Consolidated Appropriations Act of 2021, extends the WOTC to cover individuals who begin work for an employer on or before December 31, 2025.
It is possible to claim both credits in the same year. However, the R&D tax credit and WOTC are both credits that comprise the Internal Revenue Code Section 38, General Business Credit (GBC). As such, the total GBC allowed for any tax year is subject to certain limitations based on the taxpayer’s filing status. Any unused credits can be carried back one year and carried forward a maximum of 20 years.
In many cases, companies that qualify for these credits are surprised to find that the normal day-to-day activities they are already engaged in are precisely what makes them eligible. If you think these credits may apply to your business, contact your accounting professional and explore the opportunities that are available to the manufacturing industry.
Marcum monitors developments with tax credits and incentives and welcomes you to contact our team for any questions you might have.