3 Tax Credits that companies often overlook
Let me preface this by saying that I am not a tax professional. The information in this article is for educational purposes only. Please inquire with your appointed tax professional to see if your business qualifies for any tax credits. Now, let’s get started.
It’s important that business owners understand how tax credits and tax deductions differentiate from one another. Here’s a quick explanation:
Tax Credits vs. Tax Deductions:
Tax Credits are very straightforward. Once the amount has been calculated, the credit is used to reduce your current tax liability. For example, your $1,000 tax credit will lower your bill by $1,000.
Tax Deductions are a little more complex, as they are used in determining your tax bracket and tax bill. For example, an individual filing single reports earned income of $85,000 for the 2021 tax year. That would land them in the 22% Federal Tax bracket. Their tax bill would be $14,647.50. See calculation below:
12% tax rate would apply to the first $40,525 earned. The remaining $44,475 would be taxed at the 22% rate.
0.12 x $40,525 = $4,863
0.22 x $44,475 = $9,784.50
$4,863 + $9,784.50 = $14,647.50
Now that the tax bill has been determined, you can either take a Standard Deduction or an Itemized Deduction. More variables come into play here, with State Deductions, Special Considerations, Carrying forward losses, etc. But we’re not going to go into that, as the purpose of this article is for Tax Credits.
3 Tax Credits that organizations often overlook:
Most businesses fail to fully maximize their tax saving potential. This could result in tens of thousands or even hundreds of thousands of dollars in lost opportunities. Here are three tax credits that organizations often overlook:
1. R&D Tax Credit
Federal Research and Development Tax Credits are one of the best ways for U.S. based businesses to reduce their tax liability. This incentive was created in 1981, to encourage companies to invest in innovation, and increase technical jobs in America. Businesses of all sizes have an opportunity to claim R&D tax credits.
How you may qualify:
-Developing or Designing New Products
-Enhancing your Existing Products
-Conducting Experiments
-Testing New or Existing Products
How to claim:
Companies may claim for current and prior tax years, as long as the R&D activities are well documented. The following will be helpful in building a claims case:
-Project Notes & Lists: Be very specific here and try to provide as much detail about every task performed.
-Blueprints, Patents, Prototypes: Supporting internal and legal documentation is a must.
-Payroll Records: Provide records of compensation paid out to employees directly involved with the project.
-Expense Details: Provide receipts for the costs of supplies, services, and contractors directly involved with the project.
-Employee Testimonies: Have the employees that are involved with the R&D activities provide detailed insight on their experience and results.
Why do organizations overlook R&D Tax Credits?
Many people associate the term ‘Research and Development’ with scientists in white lab coats conducting experiments. When in reality, a broad range of business activities qualify for these credits. If your company is working to improve a process or product, on U.S. soil, it may make sense to see if you qualify.
R&D tax credits can range between 10-13% of the costs toward qualified research. And that’s just at the federal level. Some states also offer R&D tax credits at varying rates.
2. Work Opportunity Tax Credit
The Work Opportunity Tax Credit (WOTC) is offered to businesses for hiring and employing certain targeted individuals. It was designed to help those who face barriers to entry in the workforce.
Individuals that qualify:
-Qualified IV-A Recipient: A “qualified IV-A recipient” is an individual who is a member of a family receiving assistance under a state program funded under part A of title IV of the Social Security Act relating to Temporary Assistance for Needy Families (TANF). The assistance must be received for any 9 months during the 18-month period ending on the hiring date.
-Qualified Veterans: A “qualified veteran” is a veteran who is any of the following:
A member of a family receiving assistance under the Supplemental Nutrition Assistance Program (SNAP) (food stamps) for at least a 3-month period during the 15-month period ending on the hiring date
Unemployed for periods of time totaling at least 4 weeks (whether or not consecutive) but less than 6 months in the 1-year period ending on the hiring date
Unemployed for periods of time totaling at least 6 months (whether or not consecutive) in the 1-year period ending on the hiring date
Entitled to compensation for a service-connected disability and hired not more than 1 year after being discharged or released from active duty in the U.S. Armed Forces or
Entitled to compensation for a service-connected disability and unemployed for periods of time totaling at least 6 months (whether or not consecutive) in the 1-year period ending on the hiring date
See IRS Notice 2012-13 for more detailed information.
-Qualified Ex-Felons: A “qualified ex-felon” is a person hired within a year of: Being convicted of a felony or Being released from prison for the felony.
-Designated Community Resident: A DCR is an individual who, on the hiring date:
Is at least 18 years old and under 40 and
Has a principal residence within one of the following:
An Empowerment Zone (EZ) or
A Rural Renewal County (RRC)
When determining the credit, wages do not include wages paid or incurred for services performed while the individual's principal place of residence is outside an EZ or RRC. See the instructions to Form 8850, Pre-Screening Notice and Certification Request for the Work Opportunity Credit, for the current list of EZ and RRC designations.
-Vocational Rehabilitation Referral: A “vocational rehabilitation referral” is a person who has a physical or mental disability and has been referred to the employer while receiving or upon completion of rehabilitative services pursuant to:
A state plan approved under the Rehabilitation Act of 1973
An Employment Network Plan under the Ticket to Work program or
A program carried out under the Department of Veteran Affairs
-Qualified Summer Youth Employee: A “qualified summer youth employee” is one who:
Is at least 16 years old, but under 18 on the hiring date or on May 1, whichever is later
Only performs services for the employer between May 1 and September 15 (was not employed prior to May 1) and
Resides in an Empowerment Zone (EZ)
-Qualified Supplemental Nutrition Assistance Program (SNAP) Benefits Recipient: An individual who on the hiring date is:
At least 18 years old and under 40 and
A member of a family that received SNAP benefits for:
the previous 6 months or
at least 3 of the previous 5 months
-Qualified Supplemental Security Income (SSI) Recipient: A “qualified SSI recipient” is an individual who received SSI benefits for any month ending within the 60-day period that ends on the hire date.
-Long-Term Family Assistance Recipient: A "long-term family assistance recipient" is an individual who, at the time of hiring, is a member of a family that meet one of the following conditions:
Received assistance under an IV-A program for a minimum of the prior 18 consecutive months
Received assistance under an IV-A program for a minimum 18-month period beginning after 8/5/1997 and it has not been more than 2 years since the end of the earliest of such 18-month period or
Ceased to be eligible for assistance under an IV-A program because a federal or state law limited the maximum time those payments could be made, and it has been not more than 2 years since the cessation of such assistance
-Qualified Long-Term Unemployment Recipient: A “qualified long-term unemployment recipient” is an individual who has been unemployed for not less than 27 consecutive weeks at the time of hiring and who received unemployment compensation during some or all of the unemployment period.
How to claim:
The Internal Revenue Service states:
An employer must pre-screen and obtain certification from the appropriate Designated Local Agency (referred to as a State Workforce Agency or SWA) that an employee is a member of a targeted group to claim the credit.
To satisfy the requirement to pre-screen a job applicant, on or before the day that a job offer is made, a pre-screening notice (Form 8850, Pre-Screening Notice and Certification Request for the Work Opportunity Credit) must be completed by the job applicant and the employer. As stated by the IRS.
On page two of Form 8850, there are four dates that must be provided before Form 8850 can be submitted to a SWA. They are the dates that the job applicant Gave information, Was offered the job, Was hired, and Started the job. (1)
Why do organizations overlook WOTC?
Unlike the misconception around who can qualify for R&D credits, when it comes to WOTC, many individuals just aren’t aware that these credits exist. Or they didn’t know how the IRS classified each and every qualified individual.
The three main variables in calculating the credit are based on the category of qualified individuals (list above,) wages paid in their first year, and total hours worked.
The maximum credit for this benefit is based on the type of qualified individual. Some max out at $9,000 per full-time employee, others at $2,400.
3. Employee Retention Tax Credit (COVID-19)
Congress passed a financial relief bill for businesses that were partially or fully suspended, due to COVID-19. The CARES Act (Coronavirus Aid, Relief, and Economic Security Act) was designed to encourage businesses to keep employees on their payroll. In return, they would be eligible to receive an Employee Retention Tax Credit.
How you may qualify:
Eligible employers can claim this credit for wages paid after March 12, 2020, and before January 1, 2021.
The Internal Revenue Service states: “The credit is available to all employers that have experienced an economic hardship due to COVID-19. This includes tax-exempt organizations.” (2)
Only two exceptions apply:
Federal, state and local governments and their instrumentalities, and
Small businesses that receive small business loans under the Paycheck Protection Program.
How to claim:
Beginning with the second calendar quarter of 2020, to claim the credit, employers should report their total qualified wages and the related health insurance costs for each quarter on their quarterly employment tax returns, usually Form 941, Employer's Quarterly Federal Tax Return.
They can receive the benefit of the credit even before filing by reducing their federal employment tax deposits by the amount of the credit. Then they will account for the reduction in deposits due to the Employee Retention Credit on the Form 941. (2)
Why do organizations overlook the Employee Retention Tax Credit?
Utilization of this tax credit is very low in relation to the eligible percentage of businesses that kept their employees on payroll during the qualifying dates. I’ve spoken about this with many business owners, and to my surprise, a majority of them had no clue this was an option.
The tax credit is 50% of up to $10,000 in qualified wages paid to an employee. The employer's maximum credit for qualified wages paid to any employee is $5,000. Qualified wages include the cost of employer-provided health care.
Example. Eligible employer pays Employee B $8,000 in qualified wages in Q2 2020 and $8,000 in qualified wages in Q3 2020. The credit available to the employer for the qualified wages paid to Employee B is equal to $4,000 in Q2 and $1,000 in Q3 due to the overall limit of 50% of up to $10,000 of qualified wages per employee for all calendar quarters. (2)
If you’re interested in learning more strategies to improve your bottom line, please visit us at www.goluminescent.com to schedule an appointment!
(1.) https://www.irs.gov/businesses/small-businesses-self-employed/work-opportunity-tax-credit
(2.) https://www.irs.gov/newsroom/new-employee-retention-credit-helps-employers-keep-employees-on-payroll
