By Judah LaVine, Partner
Carrazco – Innovative Tax Solutions
Too often available tax credits are not identified or even looked into as they are often too specialized or unknown to businesses and their accountants. But in today’s business climate, taking full advantage of available tax credits and incentives is imperative to keeping your business thriving. Here are a few tax credit strategies that have saved California employers millions of dollars
EMPLOYEE RETENTION TAX CREDIT
The Employee Retention Tax Credit (ERTC) is a federal tax credit created under the CARES Act, and subsequently updated through the American Rescue Plan Act of 2021 (ARPA). Created to help businesses avoid layoffs during the coronavirus pandemic, the ERC offers a refundable payroll tax credit to both for-profit and non-profit eligible business. Any business that:
- Had to be fully or partially suspended due to government order,
- Had a decrease in gross receipts of 50% or more for any quarter in 2020 compared to the same quarter of 2019, or
- Had a decrease in gross receipts of 20% or more in a quarter in 2021 compared to the same quarter in 2019 may be eligible for this credit.
The Employee Retention Tax Credit can be significant and add up to as much as $26,000 per employee of refundable payroll tax credits. It’s important to keep in mind there are several nuances to determining eligibility and calculating the credit. For instance, businesses that received the Paycheck Protection Program (PPP) loans cannot use the wages used in the determination of the loan to calculate the ERTC. “Backing out” PPP wages from the ERTC credit calculation can be quite tricky, but imperative to ensure the business doesn’t “double-dip” on qualified wages.
The IRS has declared 5 years for the statute of limitations (SOL) for review, compared to the typical 3 years a business would typically see with a federal review. The IRS is not hiding the fact that the ERTC will be a credit that will be reviewed almost certainly. It is expected that audits will begin in 2022.
RESEARCH & DEVELOPMENT TAX CREDIT
The R&D Tax Credit is a federal tax credit (also available in many states) designed to promote innovation. It allows companies to receive tax credits for expenses incurred for research and development, thereby lowering their tax obligation and increasing funds for future innovation.
Most qualifying expenditures result from the wages paid to employees that participate in qualifying activities. As a result, the potential for R&D tax credits can be substantial and offer an excellent source of extra cash, up to 10% of annual R&D costs for federal purposes and much more when state credits are factored in. If your company has been engaged in qualifying activities for the last several years, you may be eligible to claim R&D tax credits retroactively.
Be careful though! It’s critical to be thorough when calculating and documenting qualified research activities for R&D tax credit claims. A possible consequence is increased IRS scrutiny and disallowance of credits claimed. Working with an experienced R&D firm that provides support in the event of an IRS review is paramount when conducting a study.
HIRING TAX CREDITS (FEDERAL & STATE)
The federal and state hiring credits are tax credit programs that motivate employers to hire and retain employees from specific target groups, including unemployed individuals, social assistance recipients, veterans, and qualified youth. For each eligible employee hired, a business can qualify for a tax credit.
Important to note, that while qualification categories are similar for both federal and state credits, each one has its own set of criteria your business must fall into to qualify.
- WORK OPPORTUNITY TAX CREDIT (Federal)
The Work Opportunity Tax Credit (WOTC) is a federal tax credit program available to employers who hire employees in specific target demographics. Credits are based on which qualification category is being met and how many hours each qualifier worked during the year. For each eligible employee you hire, your business can qualify for a tax credit of up to $9,600 during the first two years of employment — which can quickly add up to significant savings.
- NEW EMPLOYMENT CREDIT (California)
The New Employment Credit (NEC) is a California income tax credit for businesses located in former enterprise zones and areas with high unemployment or poverty (also known as the DGA). It excludes temporary help agencies, retailers, and food services, unless those businesses have less than $2 million in gross receipts (small businesses). Eligible employees also must make 1.5 times the minimum wage to meet qualification criteria. The amount of the tax credit award depends on each company’s unique set of factors, but each qualifying employee can garner up to $100,000 worth of credits over a five-year period.
Even though hiring credits have been available for more than 20 years, many companies continue to fail in capturing these valuable credits because the process to obtain certifications for eligible employees is time-consuming and tedious. Since most employers hire new staff without consideration of potential tax credits, they have no system for filing for the WOTC or NEC.
For many employers WOTC and NEC tax credits can aggregate to substantial amounts without even changing their hiring practices. The key to securing the credits is to implement a system that makes employee qualification a seamless part of the hiring process. In doing so, employers can maintain their existing process for hiring new employees while still actively screening for qualified employees which ultimately translates into the potential for hundreds of thousands (sometimes millions) in tax savings.
COST SEGREGATION
Cost Segregation is a commonly used strategic tax planning tool that allows companies and individuals, who have constructed, purchased, expanded, or remodeled any kind of real estate to increase cash flow by accelerating depreciation deductions and deferring federal and state income taxes. When a property is purchased, not only does it include a building structure, but it also includes all of its interior and exterior components. On average, 20% to 40% of those components fall into tax categories that can be written off much quicker than the building structure.
A Cost Segregation Study dissects the construction cost or purchase price of the property that would otherwise be depreciated over 27 1⁄2 or 39 years. The primary goal of a cost segregation study is to identify all property-related costs that can be depreciated over 5, 7, and 15 years. For example, certain electrical outlets that are dedicated to equipment such as appliances or computers should be depreciated over five years. Considering the concept of “time value of money”, the resulting benefit can be substantial by offering hundreds of thousands of dollars of accelerated depreciation and therefore reducing tax burden significantly.
A quality engineering-based cost segregation study is the key to maximizing your benefit, allowing building owners to write off their building (new and existing) in the shortest amount of time permissible under current tax laws. The favorable depreciation rules contained in the Tax Cuts & Jobs Act (TCJA) create incentives for the greater use of cost segregation studies.
It’s important to work with a Cost Segregation expert that has the right experience and can deliver a quality study that meets all IRS guidelines.
EMPLOYMENT TRAINING PANEL
The California Employment Training Panel (ETP) is a reimbursement program given to employers to assist with the cost of training new employees. In efforts to keep California businesses competitive, the ETP provides cash funding to businesses that enhance the skills of their workforce through the training of their employees. Manufacturing & Fabrication companies and all levels of Construction and Food Production & Information Technology Services are great candidates for this program. Keep in mind, the ETP program presents reimbursement checks as opposed to tax credits.
The application process and timeline for application final approval can be lengthy, ranging between 4-12 months depending on the level of current funding into the program and overall number of applicants. However, with the appropriate guidance and perseverance, the award once approved is typically well worth the effort. Depending upon client size, first time applicants are usually limited to a maximum of $250,000 and repeat clients are limited to $500,000 in training reimbursement over a 2-year period.
For additional information, please contact one of the experts at Carrazco – Innovative Tax Solutions at (916) 442-2519.
Managing Partner – Uri Carrazco, CPA