Thousands of tax credits, deductions and other incentives are hidden throughout the Tax Code. Some, such as the Blender's Credit, are obscure, while others, such as the Earned Income Tax Credit or the various energy credits, are well known.
These provisions, both for individuals and businesses, are an important part of the tax landscape, yet they can be complicated. Although many of them appear and disappear at the whim of Congress, taxpayers and their advisors can unlock significant tax savings through judicious use of credits and incentives.
Congress has a long history of using the Tax Code to encourage certain types of behavior, according to Dan Shapiro, a tax partner at New York-based firm Berdon. "Tax credits and incentives are intended to be indirect subsidies for investment in different areas, as well as inducements to engage in particular behavior," he said.
Those include personal credits, designed to furnish benefits and incentives to certain taxpayers such as elderly or disabled individuals; business credits, which further incentives to businesses; and the foreign tax credit, which may be available to both individuals and businesses. Other code categories, such as the depreciation regime, provide significant incentives to engage in business investments.
Bonus depreciation, introduced about a decade ago, has greatly increased the incentive for certain types of real estate investments, according to Shapiro.
"It's most useful application to real estate is the type of property that includes qualified leasehold improvement property," he said.
"The extension and expansion of bonus depreciation has somewhat eclipsed the attention that was paid to Code Section 179 [the firstyear expensing write-off]," he said. "For the first time, bonus first-year depreciation is 100 percent, for property placed in service after Sept. 8, 2010, and before Jan. 1, 2012. Property that qualifies can be completely written off in its first year."
Property eligible for the deduction includes most tangible personal property, computer software, and qualified leasehold improvement property. "Qualified leasehold improvement property includes self-constructed property, such as when a landlord hires a contractor to build out space for a tenant," said Shapiro. "This type of incentive encourages economic activity in two ways. It encourages the initial investment in qualifying property, and the first-year write-off generates immediate tax-savings cash flow to re-invest in the business."
Despite the economic benefits of the incentive, Shapiro noted that a number of states, including New York, have opted out of bonus depreciation, most likely due to revenue concerns.
SMALL-BIZ HEALTH CARE CREDITS
The new Small Employer Health Insurance Credit, part of last year's health care law, is so complicated that many businesses forego the credit, according to Tim Morrison, a benefits broker and chief executive of Tax Credits. "Many think it's too complicated and they won't qualify anyway," he said.
The credit is offered to eligible small employers, which are employers with no more than 25 full-time-equivalent employees, and whose employees have average annual wages of no more than $50,000.
Both the full-time employees and the average annual wages are calculated according to varying formulas. "You can have full-time employees in multiple states, and you have to use an average premium for each employee's state in your calculation," said Morrison. "And each calculation can be measured in hours, days or weeks."
Because the tax credit's matching rate is highest for employers with 10 or fewer full-time-equivalent employees, the number of hours worked is a crucial factor in calculating the credit. The credit is worth up to 35 percent of a small business' premium costs in 2010, and increases to 50 percent in 2014.
"A lot of people were turned off by the credit because of so many qualifications and exclusi ons," said Peter Isberg, vice president of government affairs for payroll and benefits outsourcer ADP.
Isberg noted that the credit phase-out increases rapidly: "The credit phases out so fast that for some it doesn't seem that big a benefit. But it can be very substantial, so accountants should take the time to learn about it so they can help their small-business clients."
Roger Harris, president of Padgett Business Services, agreed. "On the surface it sounds simple, but you have to calculate wages and employees. You can be under both thresholds and still have a zero credit if you have the wrong combination of wages and employees," he said. "Anecdotally, few credits have been taken so far. For that to happen in a tight period of time is unusual. For businesses that qualify, it's a very nice credit, but it's not likely that it motivated anyone to provide health insurance that wasn't already providing it. In fact, there may be instances where it had an adverse effect, since a business might be motivated to actually lower the number of employees or wages in order to qualify."
THE HIRE ACT
More than half of the employers that qualified to take the payroll tax exemption under the HIRE Act in 2010 filed to do so, noted Isberg. "Many employers actually hired people who qualified, but they didn't know enough to fill out the Form W-11. It's worth quite a bit of money, so they should go back and amend their return. There's also the New Hire Retention Credit, for anyone who qualified as a new employee under the HIRE Act, and is still employed 52 weeks later."
The Small Business Jobs Act enacted last September greatly increased the value of the R&D credit, according to Brandon Edwards, president of The Tax Credit Company, a tax incentive consultancy. "The act changes the operation of the research credit for eligible companies," he said. "In the past, the credit did not offset the Alternative Minimum Tax, so the maximum amount of a credit a company could use was limited to the amount their regular tax was greater than their AMT. The Jobs Act makes the credits you generate in 2010 offset the AMT. It applies to all federal tax credits, so it includes the Empowerment Zones Credit and Work Opportunity Credit, as well."
Under the Jobs Act, general business credits, including the R&D credit, generated during 2010 offset both regular income tax and the AMT of eligible small businesses, which include sole proprietorships, partnerships and non-public corporations with $50 million or less in average annual gross receipts for the prior thee years.
In the past, it had been common for a small manufacturer to generate $250,000 in research credit that it couldn't use, Edwards noted. "Now they can use all of it. If they can't offset all the tax this year, they can carry it back five years."
There is now more clarity as to what qualifies for the credit as a result of a number of court cases, most of which have been decided in favor of the taxpayer, Edwards noted. "Even if the amount of research is remaining steady or decreasing, you can still benefit from the credit on the federal side," he said. "On the state side you can never assume that the taxpayer is increasing research until you do the calculations. A company that is performing qualified activities within a jurisdiction should run the calculations to determine if it qualifies, and not assume that research is increasing or decreasing, because the rules are different for each jurisdiction."
"The message here is that accountants should take another look at the research credit," he said. "The bar has really been lowered as far as the level of innovation that is necessary to qualify for the credit. This is partly a reflection of the competitive pressure. Thirty years ago, the credit was more valuable in the U.S. compared to any other county. Now, we're ranked seventeenth in the world. Mexico, Canada, China, Japan and the U.K. all have better research credits than we do now."
"They take different forms," he observed. "Some are accelerated super-deductions, rather than credits, but the equivalent value provides a greater incentive than we do. Because of that, we should see the trend continue to be favorable for businesses that are engaged in those activities."
Carl Giordano, a tax partner in the Boston office of CPA firm Marcum, agreed. "In 1981, we were first over other countries in providing the credit," he said. "The problem is that the rest of the world was right behind us. For example, Australia has a 30 percent corporate tax rate, compared to ours, which is 35 percent. On top of that, their research incentive is a super-deduction of 175 percent of the amount that was spent."
"Not only are we behind much of the world in encouraging research, the uncertainty of the credit hampers long-range planning," according to Giordano.
"Since the credit was enacted in 1981, we have allowed it to lapse 14 times, including the current lapse that was just re-instated," he said. "Most companies' R&D plans are five years out, but if the credit is only for one year, that's all you can realistically plan for. That's not going to motivate me to create jobs."
EXTENDING THE CREDIT
A bill currently before Congress would provide the needed certainty by making the credit permanent, Giordano noted. The American Research and Competitiveness Act of 2011, introduced as H.R. 942 in March, would extend the research credit through 2012 and increase (from 14 percent to 20 percent) and make permanent the alternative simplified research credit. The Obama administration has also included a permanent research credit in its budget proposal.
Although the proposed legislation would be helpful, it may take some time before Congress addresses it, according to Dean Zerbe, managing director of specialty tax service provider alliantgroup. Zerbe, formerly senior counsel and tax counsel to the Senate Finance Committee, indicated that it may be the end of this Congress, a year-and-a-half from now, before legislation is passed.
"Members [of Congress] are beginning to see how much a turnoff the AMT issue was for small businesses, and they addressed that in the Small Business Jobs Act," he said. "They're talking about permanency and increasing the alternative simplified credit, but much of the energy is being taken up by deficit and budget discussions. There's also a push to allow the alternative simplified credit on amended returns."