Companies use business tax credits to offset their tax obligations to the government or to generate savings. As we start 2023, now is a good time to take a closer look at tax credits for which you may be eligible, especially during a time of unprecedented economic strain and ongoing post-Covid recovery efforts.
Tax credits offered by federal, state and local governments promote specific corporate behavior — like investment, research and development (R&D), and job retention and creation. These programs, eligibility conditions, zone boundaries and filing requirements can change annually, so it is important to stay up to date to determine whether your company is impacted.
"For businesses of all sizes, these captured credits can make a big impact on their current year's bottom line," Steven Bright, Vice President/General Manager of Business Incentives with ADP said. "Taking time to focus on the past will help businesses meet this year's goals."
Below is a review of three instrumental tax credit opportunities, what they are, how employers can qualify for them, and how they can claim them: the Work Opportunity Tax Credit (WOTC), the Employee Retention Tax Credit (ERTC) and Research & Development (R&D) tax credits and incentives.
Work Opportunity Tax Credit (WOTC)
WOTC is a federal tax credit program that allows companies to receive tax credits when they hire individuals from defined target groups who have consistently faced significant barriers to employment.
Employers can receive tax credits of up to $9,600 per qualified new hire, depending upon the new hire's WOTC target group. The Work Opportunity Tax Credit program was designed to provide an incentive for employers to consider job applicants from targeted groups. Targeted groups include former felons, vocational rehabilitation referrals, Summer Youth program participants and recipients of Supplemental Nutrition Assistance Program (SNAP), Supplemental Security Income (SSI), or long-term Unemployment benefits, among others.
- The tax credit amount is equal to 40% of the employee's qualified wages if the employee works at least 400 hours during the first year of employment.
- If the employee works less than 400 hours, but at least 120 hours, you can claim a credit equal to 25% of the employee's qualified wages.
- Eligible employees MUST work a minimum of 120 hours to qualify. An employer cannot claim the tax credit for rehired employees.
How to claim
IRS update IR-2022-159 requires that both the employer and job applicant complete a Form 8850: Pre-Screening Notice and Certification Request for the Work Opportunity Credit on or before the date a job offer is made.
Once a job applicant has been pre-screened, employers are required to submit the Form 8850 to the appropriate state workforce agency no later than 28 days after the employee's first day of work.
Employee Retention Tax Credit (ERTC)
The CARES Act ERTC for 2020 is a 50% tax credit of up to $10,000 in qualified wages per eligible employee (a maximum credit of $5,000 per employee). For 2021, the credit is a 70% tax credit on up to $10,000 in qualified wages per quarter for Q1 through Q3, (a maximum of $21,000 per eligible employee).
As is sometimes the case with legislation, complexities and ambiguities have warranted further clarification. On April 29th, the IRS published FAQs, and legislative proposals have been submitted recommending a variety of enhancements to the ERTC. Notice 2020-21, which was released on March 1, 2021, supersedes the 2020 FAQs, which weren't considered authoritative.
An employer may qualify if its operations were at least partially suspended due to orders from a governmental authority that restricted commerce, travel or group meetings as a result of COVID-19, or if it can demonstrate that it had a significant decline in gross receipts.
For 2020 quarters, a significant decline in gross receipts occurred if the gross receipts for a quarter declined by more than 50% when compared to the same quarter in 2019. An employer with a significant decline in gross receipts continues to be eligible until the end of the quarter in which its gross receipts recover to at least 80% of receipts in the same quarter in 2019. For 2021 quarters, the gross receipts test is changed to a decline of more than 20% when compared to the same quarter in 2019.
An eligible employer who meets one of the two criteria above must have "qualified wages" in order to claim the credit. For an employer who had 100 or more full-time employees during 2019, "qualified wages" in 2020 quarters are wages paid to an employee who was not providing services as a result of the relevant government order or the significant decline in gross receipts.
For an eligible employer with fewer than 100 full-time employees in 2019, "qualified wages" in 2020 quarters are all wages paid by the employer. For 2021 quarters, the threshold for qualified wage determination is raised to 500 or more full-time employees during the 2019 base year.
How to claim
The ERTC can be computed retroactively with the refund secured by filing an amended Form 941-X. The key is understanding the unique ways governmental orders impacted business operations. Unfortunately, many lack the expertise in defining the multiple pathways to employer-level qualification.
- To get started, the business will need to identify ineligible, eligible and partially eligible employees (i.e., those working, but at reduced hours or a reduced rate).
- Transparency and a thorough analysis of the business's quarterly tax filing deposits will require critical assistance with completing either IRS Form 941 or 941X.
Research & Development (R&D) tax credit
The federal R&D tax credit results in a dollar-for-dollar reduction in a company's tax liability for certain domestic research-related expenses. Qualifying expenditures generally include the design, development or improvement of products, processes, techniques, formulas or software. Further details on the R&D tax credit are outlined under Section 41 of the Internal Revenue Code.
R&D tax credits are available to all organizations that engage in certain activities to develop new or improved products, processes, software, techniques, formulas or inventions. The Protecting Americans from Tax Hikes (PATH) Act of 2015 broadened the ability of many small-to-midsize businesses to monetize the R&D credit by making a portion of the credit available to offset payroll taxes under certain conditions.
- Generally, businesses can claim R&D tax credits for tax returns with an open statute of limitations, which typically includes the prior three years.
- If the taxpayer had non-taxable or loss years in tax years where the statute of limitations is closed, they may be able to go back several additional years to calculate credits and carry them forward to taxable years on a carryforward schedule for up to 20 years until used.
As part of the process, businesses need to identify qualifying expenses and provide adequate documentation that shows how these costs meet the requirements under Internal Revenue Code Section 41. Financial records, business records, oral testimony and technical documents may be used for this purpose.
How to claim
A taxpayer who has qualified research activities should first perform an R&D study to determine their eligibility for the credit, as well as for satisfying the substantiation and documentation requirements required by the IRS. Once the credit amount is determined, the credit is claimed by completing Form 6765 and including it with the taxpayer's income tax return.
The R&D credit can be claimed either on an originally filed return or, in the case of credits generated in prior years, on an amended return. A credit that cannot be utilized in the year in which it is generated can be carried back one year, then carried forward up to 20 years, in accordance with general business credit carryover rules.
Tax credit and incentive opportunities continue to evolve as new legislation is passed or as the IRS introduces new updates and/or guidance. To gain a broader understanding of tax credits and incentives opportunities, as well as compliance considerations, visit the ADP SmartCompliance® tax credits resource page.