Three of the most common tax credits available to businesses are the research and development (R&D) tax credit, the health care tax credit and the foreign tax credit. Companies that can take advantage of these opportunities are able to save money by reducing their tax liabilities, says Richard J. Nelson, CPA, a Director in the Tax Strategies group at Kreischer Miller.
Smart Business spoke with Nelson about these tax credits and what companies can do to maximize their value.
How does the R&D tax credit work?
The research and development tax credit is the most widely used credit by businesses and was granted permanent status last year.
Businesses that utilize this tool include all types of manufacturing companies, architectural and engineering firms and software development businesses, as well as companies engaged in developing a particular technology to enhance their core business endeavors.
The Internal Revenue Service requires that qualifying research activities satisfy four tests: Activities must be technological in nature, they must be performed for a permitted purpose, the work must be undertaken to resolve uncertainty and there must be a process of experimentation. A good rule of thumb in estimating the credit is to take 10 percent of eligible R&D expenses.
The vast majority of eligible R&D expenses consist of the wages of the individuals working on the project. Other expenses, which are usually minimal, include materials and supplies which are consumed in the project and are 65 percent of the cost of contracted labor costs.
Beginning in 2017, qualifying businesses may offset the 6.2 percent Federal Insurance Contributions Act (FICA) portion of their payroll taxes using R&D tax credits claimed on their 2016 and future federal returns.
Qualified small businesses are defined as corporations or partnerships having gross receipts of $5 million or less during the taxable year. They must also not have gross receipts for any year preceding the five-year period ending with the taxable year. R&D tax credits are applied against quarterly payroll tax payments. In any given year, the maximum payroll tax offset allowed is $250,000. Unused credits may be carried forward and used against future payroll tax payments.
The second change allows eligible small businesses to use the credit to reduce their alternative minimum tax, as well as their regular tax. Eligible small businesses include corporations whose stock is not publicly traded, partnerships and sole proprietorships that had average gross receipts of $50 million or less during the prior three years.
Many companies are missing opportunities for the credit for expenses related to technology costs, specifically website design costs. There are also recent regulations that have been issued on internal use software. Not every website or internal use software will qualify for the credit, but it is at least worth investigating.
Who is helped by the health care tax credit?
The small business health care tax credit benefits employers that have fewer than 25 full-time equivalent employees, pay average wages of less than $52,000 a year per full-time equivalent (indexed annually for inflation) and pay at least half of employee health insurance premiums.
To be eligible for this credit, you must have purchased coverage through the small business health options program, also known as the SHOP marketplace. The maximum credit is 50 percent of the premiums paid for small business employers and 35 percent of premiums paid for small tax-exempt employers.
The credit is available to eligible employers for two consecutive taxable years. If you missed claiming the credit in a prior year, you may be eligible to file an amended return.
What benefits does the foreign tax credit provide?
If your company is paying income taxes to a foreign country or a U.S. possession, you may be eligible for a foreign tax credit. Generally, only income, war profits and excess profit taxes qualify for the credit. Foreign taxes can be taken as a deduction or as a credit. In most cases, it is to your advantage to take foreign income taxes as a tax credit. ●
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