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How Manufacturers Can Take Advantage of Tax Credits and Incentives
GALLINA LLP
Largest accounting firm in the Sacramento region
Top 10, largest accounting firms in California / “Top 100 Firm” nationally
Several teams of specific industry specialists 2014 Corporate Citizen of the Year recipient
from the Boy Scouts of America, Golden Empire Council
Today’s Topics
Research & Development Tax Credit
California New Employment Credit (“NEC”)
Work Opportunity Tax Credit (“WOTC”)
Sales Tax Exemption for Manufacturing or R&D
Research & Experimentation Tax Credit
Credit for Increasing Research Activities
What is the Benefit?
Manufacturing client that designs and manufactures compressors for various applications.
Just of $1.5 million of qualifying R&D expenses.– $1,100,000 spent on salaries & wages (28 people
internally spending an average of 39% of their time performing qualifying R&D activities).
– $450,000 spent on prototype materials and testing various sealant materials.
– $32,000 paid to 3rd parties to perform qualifying research on behalf of our client.
Resulted in a tax credit of $176,000.
The Benefit
Manufacturer’s taxable wages, supply costs, and contractor costs are “deductions” which are all fully deductible on the tax return.
A tax “credit” is an additional benefit that is a dollar for dollar offset against the amount of taxes you owe.
What is a “Qualifying” Activity?
• Qualifying Activities– Engineering Efforts– New Product Design– Substantial Improvements– Computer Modeling– Experimentation Efforts– Laboratory Testing– Developing Prototypes– Technical Discussions– Unsuccessful but Otherwise
Qualifying Initiatives
• Non-Qualifying– Reverse Engineering– Market Research– Research Related to Style or
Consumer Taste– Research Related to
Management Techniques– Adaptation (simple) of an
Existing Product or Process– Research Conducted Outside
the U.S.
From Concept to Production
Concept Development
Applied Research Design Prototype First Run &
TestingCustomer
DeliverableSubsequent
Revisions
Statutory Qualifying Criteria
Permitted PurposeThe activity must relate to a new or substantially improved product or process intended to improve:- Function- Performance- Reliability- Quality
Technological in NatureThe activity must fundamentally rely upon principles of:- Engineering- Physical Science- Computer Science- Biological Science
Technological UncertaintyThe activity must be intended to discover information to eliminate technological uncertainty related to:- Appropriateness of a product design- Method of a product or process- Capability of a product or process
Process of ExperimentationSubstantially all (80%+) of the activities must relate to a systematic process of experimentation involving:- Evaluation of one or more alternatives- Confirming hypothesis through trial/error, testing and/or modeling/simulation
Four-Part Test
From Concept to Production
Concept Development
Applied Research Design Prototype First Run &
TestingCustomer
DeliverableSubsequent
Revisions
Research Pursuant to Contract
• Substantial Rights– Must retain rights to I.P.
and be able to use what is learned on subsequent projects.
– Rights do not have to be exclusive
• Risk– Fixed-price fee
arrangement– Payment contingent on
success of the research– Warranty provisions– Cannot be T&M, Cost +,
or GMP unless there is a compelling case to be made
What Expenses Can Be Included?
Salaries and Wages– Typically largest component (roughly 90%+)
Supply Costs– Cannot include capitalized assets (equipment)
Contractor Costs– 65% of qualifying costs are eligible
R&E Credit Study Process Identify Qualifying Business Components
Identify Personnel Who Were Involved
Identify Hours By Employee By Activity For Each Qualifying Business Component
Identify Supplies Consumed While Performing Qualifying Activities
Identify Contractor Costs Related to the Performance of Qualifying Activities on Qualified Projects (Business Components)
Calculate the Tax Credit Amount
Any Questions?
?
California New Employment Credit
California Hiring Incentive
Enterprise Zone Credits
The “Enterprise Zone” hiring credit has expired as of December 31, 2013.
Unused credits may carry forward for up to 10 years.
Qualifying new hires under the old program who were previously vouchered, will continue to generate credits for up to 5 years from their original hire date.
New Employment Credit (NEC)
The NEC credit applies to hiring beginning January 1, 2014 and is worth up to $56,000 per qualifying new hire, over 60 months (5 yrs)
Not available for retailers, food service, temporary employment agencies, casinos, bars, or sexually oriented businesses
Allows businesses to claim NECs in certain economic development areas (former EZs and LAMBRAs, with some exceptions), as well as in designated census tracts with high unemployment and poverty rates
Available for hiring employees who are long-term unemployed; unemployed veterans; ex-felons; or recipients of the federal earned income tax credit, CalWORKS, or general assistance
Only available to employers that create net new jobs statewide
New Employment Credit (NEC)
Tentative Credit Reservation (TCR) for each qualified employee must be made within 30 days of hire date
Hiring Credit may be taken only on an originally filed income tax return (no amended returns)
Computation of an “applicable percentage”– The net increase in full-time employees in CA is the
numerator of the fraction while the denominator is the number of “qualified” full-time employees in the state
Example 1 Situation (NEC)
Taxpayer A operates entirely within California and has a location within the DGA. As of December 31, 2013, Taxpayer A has a total workforce of 250 employees which consists of 150 part time and 100 full-time employees. During its taxable year 2014, Taxpayer A hired new full-time employees, 2 of which were qualified full-time employees. Taxpayer A received a tentative credit reservation for these employees as required. Assume the following facts:
Qualified Employee 1 was hired on January 1, 2014, at an hourly wage of $17 and worked 2,000 hours during taxable year 2014. Qualified wages for Employee 1 are $5 per hour ($18.50 - $13.50). Qualified Employee 2 was hired on July 1, 2014, at an hourly wage of $18 and worked 1,000 hours during taxable year 2014. Qualified wages for Employee 2 are $6 per hour ($19.50 - $13.50). The Base Year is taxable year 2013. In its base year, annual full-time equivalent employees were 100. Full-time equivalent employees in 2014 were 108. The net increase in annual full-time equivalent employees over the base year is 8.
Example 1 Calculation
Tentative Credit Amount: $5,600Qualified Employee 1: $3,500 ($5 x 2000 hours x 35%) plusQualified Employee 2: $2,100 ($6 x 1000 hours x 35%)Applicable Percentage: 100%Numerator: 108-100 = 8 (Net Increase in full-time
employees)Denominator: 2 qualified full-time employeesComputation: 8/2 = 100% (the applicable percentage
cannot exceed 100%)Credit Allowable: $5,600 ($5,600 x 100%)
Example 2 Situation
The qualified taxpayer has a net increase in full-time employee equivalents – receives a partial amount of the tentative credit.
Assume the same facts as Example 1, except due to attrition the annual full-time equivalents for taxable year 2014 was 101. The net increase in annual full-time equivalent employees over the base year is 1 (101-100).
Example 2 Calculation
Tentative Credit Amount: $5,600
Qualified Employee 1: $3,500 ($5 x 2000 hours x 35%) plus
Qualified Employee 2: $2,100 ($6 x 1000 hours x 35%)
Applicable Percentage: 50%
Numerator: 101-100 = 1 (Net Increase in full-time employees)
Denominator: 2 qualified full-time employees
Computation: 1/2 = 50%
Credit Allowable: $2,800 ($5,600 x 50%)
Example 3 Situation
The qualified taxpayer does not have a net increase in full-time employee equivalents – receives no amount of the tentative credit.
Assume the same facts as Example 1, except due to attrition the annual full-time equivalent for taxable year 2014 was 98. The net increase in annual full-time equivalent employees over the base year is zero (98-100 but it cannot be less than 0).
Example 3 Calculation
Tentative Credit Amount: $5,600
Qualified Employee 1: $3,500 ($5 x 2000 hours x 35%) plus
Qualified Employee 2: $2,100 ($6 x 1000 hours x 35%)
Applicable Percentage: 0%
Numerator: 98-100 = 0. (Net Increase in full-time employees cannot be less than zero)
Denominator: 2 qualified full-time employees
Computation: 0/2 = 0%
Credit Allowable: $0 ($5,600 x 0%)
Work Opportunity Tax Credit (“WOTC”)
Federal Hiring Incentive
WOTC
Currently expired as of December 31, 2013 but expected to be retroactively extended through 2015 with the EXPIRE Act.
Worth up to $9,600 per qualifying new hire.
WOTC Qualifying New Hire Credit for hiring qualifying persons. A qualifying person is:
1. A member of a family that is a Qualified Food Stamp Recipient2. A member of a family that is a Qualified Aid to Families with Dependent
Children (AFDC) Recipient3. Qualified Veteran4. Qualified Ex-Felon, Pardoned, Paroled, or Work Release Individual5. Vocational Rehabilitation Referrals6. Qualified Summer Youth 7. Qualified Supplemental Security Income (SSI) Recipient8. Qualified Individuals living with an Empowerment Zone or Rural Renewal
Community9. Long Term Assistance Recipient (TANF) – formerly known as Welfare to
Work
Claiming the WOTC
Complete Form 8850 by the day the offer is made.
Complete ETA Form 9061 or ETA Form 9062
Submit the completed and signed IRS and ETA forms to your state workforce agency (California EDD) within 28 calendar days of the employee’s start date.
Manufacturing and Research & Development Equipment Exemption
Sales Tax Exemption
Planned Purchases?
Does anyone here plan on making purchases of manufacturing or R&D equipment?
Real World Example
Client plans purchase of $17 million of manufacturing plant equipment
GALLINA received a private opinion from the State that these purchases would qualify
Client will save in excess of $700,000
Manufacturers Sales Tax Exemption
Beginning July 1, 2014 - allows manufacturers to obtain partial exemption (currently 4.1875%) of state sales and use tax on certain manufacturing and research and development equipment purchases.
To be eligible under AB 93, a Taxpayer must meet all three of the following conditions:
1. Be engaged in certain types of business, also known as “qualified person”,2. Purchase “qualified property”, and3. Use that qualified property for the uses allowed by this law
“Qualified Person” = Someone primarily engaged (50% or more of the time) in those lines of business described in the North American Industry Classification System (NAICS) Codes 3111 to 3399, inclusive, 541711, or 541712 – These industries generally include those primarily engaged in the business of all forms
of manufacturing, research and development in biotechnology, and research and development in the physical, engineering, and life sciences.
Manufacturers Sales Tax Exemption
“Qualified Property” includes the following used in manufacturing processes or R&D activities:– Machinery and equipment, including component parts and contrivances such as belts, shafts,
moving parts, and operating structures– Equipment or devices used or required to operate, control, regulate, or maintain the machinery
(computers, software, repair/replacement parts)– Tangible personal property used in pollution control that meets established state or local
government agency standards– Special purpose buildings and foundations used as an integral part of the manufacturing process, or
that constitute a research or storage facility. Buildings used solely for warehousing do not qualify.• Does not include consumables with a useful life of less than one year, furniture, inventory, equipment used in
extraction processes, equipment used to store finished products that have completed the manufacturing, processing, refining, fabricating, or recycling process, or tangible personal property used primarily in administration, general management, or marketing.
This new program applies the exemption to qualifying purchasers throughout California, without regard to geographic boundaries.
Requires the issuance of an “exemption certificate” at the point of sale.
Any Questions?
?
GALLINA LLP Contact Information
Mark Bellows, CPAPartner – Manufacturing Practice [email protected]
Jesse Wutkee, CPASenior Manager – Tax Credits & Incentives Practice [email protected]
Shevar Goonwardena, CPASenior Manager – Manufacturing Audit and [email protected]
