Why It’s Important to Annually Review Tax Credit Opportunities

It’s the time of year when companies and individuals throughout the United States deal with their federal and state tax compliance obligations. As part of that process, taxpayers need to analyze whether there are any economic incentives available to offset potential federal or state income tax liability.

Many economic incentives offered by the U.S. government via the Internal Revenue Code, such as the Research & Development (R&D) Tax Credit, Work Opportunity Tax Credit (WOTC) and bonus depreciation have been offered for decades through a plethora of temporary extensions, amounting to billions of dollars in savings on an annual basis. States that impose an income tax using federal taxable income as a starting point naturally benefit from these programs; moreover, many states either piggyback on these benefits or enhance them. This year will be the last filing under the old regime, as next year taxpayers will be subject to the Tax Cuts and Jobs Act of 2017, or H.R.1. 

Where to start?

Large expansion projects and new projects are perhaps more obvious and would have likely garnered discretionary and statutory economic incentives at the time of site selection or initial project consideration, but it’s important to consider all the other routine business activities:

• Did you hire new employees?
• Did you train new or existing employees?
• Did you invest capital?
• Have you analyzed where your facilities are located and whether they are geographically favored?
• Did you engage in any research and development for products or processes?
• Have you increased your utility load factor?
• Did you make any energy efficiency improvements or generate wind or solar power?
• Were you unfortunately impacted by a natural disaster?

All the above business triggers may yield statutory economic incentives, even if they are considered after the fact.

What are the benefits?

Aside from federal income tax credits and deduction provisions above, many states offer their own equivalent of statutory credits (e.g., Texas franchise tax credit/sales tax exemption related to R&D).  Oftentimes, state level credits may differ in terms of eligibility, amount or both. Some other key state-level statutory tax benefits to consider are:

• Job tax credits
• Including hiring special categories of employees (veterans, enterprise zone, WOTC, etc.)
• Investment tax credits related to capital investment
• Including making investments in favored properties/locations (e.g., historic tax credit, brownfield tax credit)
• Investment tax credits related to capital investment
• Training credit/deduction
• Utility incentives – energy rebates, rate riders
• Hurricane Disaster Zone Employee Retention Credit

How are tax incentives structured?

Companies generally pay tax at a federal level on their profits and at a state level based on a company’s footprint in the state, which is calculated based on each state’s apportionment formula. The apportionment formula is calculated using the ratio of a company’s property, payroll and sales in a state to its total amount of property, payroll and sales everywhere. Each state has its apportionment methodology and sourcing rules, which could vary depending on selling tangible personal property versus the sale of services or throwback versus throwout rules, etc. In general, many states have progressed toward a single sales factor so as not to “penalize” a company for having property or payroll in the state.

Tax benefits can come in the form of a tax credit or a tax deduction. Credits are subtracted from the amount of tax owed, while deductions are subtracted from a company’s income before applying the tax rate. Credits are a $1:$1 offset against tax liability, while tax deductions are used to reduce taxable income and yield a benefit in the amount of the deduction multiplied by the effective tax rate. As an example, assume a company spends $1 million on capital investments during the year and a jurisdiction offers either a 25% credit based on the amount of the capital investment or a deduction in the amount of the investment. The total benefit is as follows:

Tax credit: $1,000,000 * 25% = $250,000 credit against tax liability

Tax deduction: $1,000,000 * 15% (effective tax rate) = $150,000 reduction in tax liability

Annually evaluating a company’s ability to capture credits is important not only in reducing potential tax liability, but also for accurately and timely being able to carry forward any credits that may not be utilized in the current year. In addition, some credits may be refundable, transferable and/or saleable.

Conclusion

States continue to analyze their tax credits and improve them as necessary to recruit business. Companies should never assume that they will not qualify for benefits in the current year simply because they didn’t qualify last year. States continue to add enhancements to their programs such as applicability to withholding and salability. Another major consideration for the 2018 tax year is how states will conform to the new federal tax law for items such as the immediate deducting of capital expenses. Legislative sessions this year should be very interesting and may have a huge impact on existing incentive programs as we move forward. With all of this in mind, companies should annually assess available tax incentives and their applicability to business operations and tax liability.

For additional information about how tax credits may apply to your business operations, please contact Site Selection Group.