Take Advantage of Tax Credit Opportunities for Manufacturing Companies
Manufacturing companies of all sizes can access several tax credits for activities related to encourage innovation and job growth. The purpose of these credits is to spur advancements in technology, new products, new processes and inventions that keep the U.S. at the forefront of innovation. They can enable businesses to make capital investments, hire new employees, grow existing operations, invest in new service lines and products, all while substantially reducing their tax liability.
Many manufacturing businesses assume they do not qualify for these tax credits; however, many normal business activities may qualify. If your business activities are eligible, your tax advisor can help you explore the following tax credit opportunities:
Research and Development Tax Credit – Federal and State
The federal government and 36 states recognize the positive economic impact of research and development (R&D) activities conducted within the U.S. by offering tax credits that can stimulate capital investment and reduce tax liability.
Established 40 years ago, the federal R&D tax credit is a dollar-for-dollar credit available to businesses of all sizes. It can apply to a wide range of manufacturing activities, including:
- Core R&D activities
- New product development/design
- New processes development/design
- New manufacturing processes development/design
- New product manufacturing trials
- Prototype development or pilot processes
- Performance of environmental testing
- Enhancements to existing products or processes
- Technology development for regulatory compliance
Most companies can calculate the federal R&D tax credit when preparing their annual tax compliance filings. To claim the credit, a manufacturer must concurrently document its research activities to establish the amount of qualified research expenses paid for each qualified research activity. Some expenses can be estimated, but there must be a factual basis for the assumptions used to create the estimates. Typical documentation may include project notes, project lists, payroll records and general ledger expense details.
First-time applicants may have additional opportunities for tax savings. If a company has never applied for the federal R&D tax credit in the past, it can amend its tax filings to capture the previous three years of activity. First-time applicants often generate a large refund, depending on their previously paid taxes, or a sizable tax credit that can be carried forward for 20 years.
Many states also offer significant R&D tax credit opportunities that generally follow federal guidelines for qualification activities, but they may apply their own application methodologies and calculations. Check with your tax professional to explore the opportunities available for your state.
CARES Act – Treatment of Net Operating Losses
The Coronavirus Aid, Relief, and Economic Security (CARES) Act allows companies that incurred net operating losses (NOLs) in 2018, 2019 or 2020 to carry the losses to each of the five tax years preceding the tax year of such loss. The CARES Act temporarily amended the limitation that NOLs could be used to offset no more that 80% of taxable income.
This relief can create immediate cash flow for many manufacturers. While this provision can be very beneficial, for many businesses, some taxpayers may experience unintended consequences. Without making a proper tax election, the refund expected as a result of carrying back NOLs may be applied against remaining Section 965 installments payments instead of providing the taxpayer a true refund. Business with controlled foreign corporations should carefully consider the interplay of NOL carrybacks with other Internal Revenue Code (IRC) provisions, especially the transition tax imposed under IRC Section 965. Companies also should consider the effect of carrying back NOLs on foreign tax credits, research and development (R&D) credits and alternative minimum tax (AMT) liability.
CARES Act – Provisions for Depreciation
Another aspect of the CARES Act is a correction made to an error in the Tax Cuts and Jobs Act of 2017 (TCJA) regarding the life of qualified improvement property. Qualified improvement property is any improvement made by a taxpayer to an interior portion of commercial property. Under the CARES Act, qualified improvement property is now classified as 15-year property eligible for bonus depreciation. The change applies retroactively to property placed in service in 2018 as well, which may provide taxpayers with the opportunities to file amended returns.
Manufacturers can maximize depreciation deductions to lower 2020 taxes or increase NOLs for a potential refund or carryback opportunity. Companies that bought new equipment or remodeled facilities should consider these benefits.
Payroll Tax Credit – Federal R&D Tax Credit
Qualified small businesses (QSB) can take the R&D tax credit against their payroll taxes (the employer-paid FICA of 6.2%) for tax years beginning in 2016. A QSB is a company that was formed in or after 2017 and has less than $5 million in annual gross receipts. The Protecting Americans from Tax Hikes Act of 2015 (The PATH Act) extended this tax-saving opportunity which essentially is a refundable credit that caps at $250,000 for up to five years.
The election to offset payroll taxes must be made on a timely filed income tax or informational return, including extensions. For partnerships or S corporations that are QSBs, 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.
Work Opportunity Tax Credit
The Work Opportunity Tax Credit (WOTC) encourages workplace diversity by making a tax credit available to employers who hire individuals from certain target populations who have faced barriers to employment. These targeted groups include: qualified veterans, qualified IV-A recipients, ex-felons, designated community residents, vocational rehabilitation referrals, summer youth employees, Supplemental Nutrition Assistance Program (SNAP) recipients, Supplemental Social Security Income (SSI) recipients, long-term family assistance recipients and qualified long-term unemployment recipients.
Established in 1996, the WOTC was due to expire in 2020 but it was extended through the Taxpayer Certainty and Disaster Tax Relief Act of 2020, a part of the Consolidated Appropriations Act of 2021.The WOTC covers individuals who begin work for an employer on or before December 31, 2025.
The WOTC is based on qualified first-year wages for members of targeted groups. It generally is equal to 40% of the first $6,000 of wages, for a maximum credit of $2,400 per employee. For certain target groups, it can provide an even greater tax incentive than the general maximum credit. For several categories of qualified veterans, more than $6,000 of first-year wages is eligible for the credit and the increased wage amounts for qualified veterans range from $12,000 to $24,000 per employee. 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).
Each potential employee is subject to a pre-screening application process and specific requirements must be met before an employer is eligible for the WOTC. These include the certification and verification of a job applicant’s status as a qualifying member and the submission of IRS Form 8850 with ETA Form 9061 or ETA Form 9062 to the company’s state workforce agency. The company must submit the required forms and application 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, then the employer may claim the WOTC.
It is possible to claim both the R&D tax credit and the WOTC in the same year. However, both are credits that comprise the Internal Revenue Code Section 38, General Business Credit (GBC). 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 for a maximum of 20 years.
Employee Retention Tax Credit
The CARES Act also created the Employee Retention Tax Credit or ERTC. The credit:
- Equaled 50% of qualified employee wages paid by an eligible employer in an applicable 2020 calendar quarter,
- Was subject to an overall wage cap of $10,000 per eligible employee, and
- Was available to eligible large and small employers.
The Consolidated Appropriations Act (CAA), enacted December 27, 2020, extends and greatly enhances the ERTC. Under the CARES Act rules, the credit only covered wages paid between March 13, 2020, and December 31, 2020. The CAA extended the covered wage period to include the first two calendar quarters of 2021, and now the recently passed American Rescue Plan Act extends the covered wage period to December 31, 2021.
In addition, the CAA increased the overall covered wage ceiling to 70% of qualified wages paid during the applicable quarter (versus 50% under the CARES Act), and it increased the per-employee covered wage ceiling to $10,000 of qualified wages paid during the applicable quarter (versus a $10,000 annual ceiling under the original rules). Most importantly, PPP borrowers who were previously not eligible to take advantage of the ERTC under the rules of the CARES Act can now take advantage of this opportunity. Visit our Employee Retention Credit Guide to learn more about all the taxpayer-favorable changes.
If you have questions about the tax credits available for manufacturing companies, feel free to contact any of our Federal and State Credit Advisors.