A key aspect of tax planning includes careful management of the timing of income and deductions to reduce a business’ income tax and therefore increase cash flow. However, another key component of tax planning and compliance is ensuring that a business is utilizing all available income tax credits.
Don’t Leave Cash on the Table
While a deduction reduces taxable income by the dollar amount of the deduction (which lowers taxes paid by the tax rate), a tax credit is generally a dollar-for-dollar direct reduction in the amount of income tax paid. In addition, a deduction usually requires an expenditure of cash.
However, to obtain an income tax credit, no additional expenditure may be required. Therefore, a credit is normally a much more valuable tax-planning item. Not claiming a credit when the business qualifies is “leaving money on the table.” However, careful tax planning may be required in order to claim many income tax credits and to ensure all information is properly captured to substantiate the amount of the credit. Below is a brief summary of some of the more common income tax credits available to businesses.
Federal Income Tax Credits
R&D Credit—This credit is available for businesses that incur research and development expenses. The credit is based on the amount of incremental R&D expenses over a base year amount. R&D expenses include wages, supplies and contract R&D. An alternative incremental credit that utilizes reduced credit rates and fixed-base percentages can be elected. Also, Congress created an alternative simplified credit in 2006 in order to make this credit available to more businesses. The alternative simplified credit is equal to 12 percent of the amount by which the current R&D expenses exceed 50 percent of the average of the previous three years’ R&D expenses.
Work Opportunity Credit—This credit provides employers an incentive to hire persons from targeted groups that have particularly high unemployment rates. The credit is a percentage of the qualified wages paid during an employee’s first year of employment, based on the number of hours worked. The targeted include certain qualified individuals in the following groups: veterans, welfare and SSI recipients, ex-felons, vocational rehabilitation referrals and summer youth employees. In 2007, Congress included high-risk youths (defined as between the ages of 18 and 40) from certain rural communities for wages paid after May 25, 2007, making this a much more attractive credit for employers in rural counties.
Disabled Access Credit—This credit is available to eligible small businesses for expenditures incurred to make a business accessible to disabled individuals. The amount of the credit is 50 percent of the amount that the eligible expenditures for the year exceed $250 but do not exceed $10,250.
Credit for Employer-Paid Social Security Taxes on Employee Cash Tips—This credit is available to employers operating food and beverage establishments for a portion of the employer social security taxes paid on employee cash tips.
New Retirement Plan Setup Credit—This credit is available to eligible small employers for some of the costs of establishing new eligible retirement plans. The credit equals 50 percent of the start-up costs incurred to create or maintain a new employee retirement plan. The credit cannot exceed $500 in any tax year and can be claimed for the year the retirement plan is established and two subsequent years.
Employer-Provided Child Care Credit—This credit was created as an incentive for businesses to provide childcare for their employees. The credit is equal to 25 percent of the qualified childcare expenses plus 10 percent of the qualified childcare resources and referral expenditures. The credit for any tax year cannot exceed $150,000.
Illinois Income Tax Credits
Enterprise Zone Investment Credit—This credit is equal to 0.5 percent of the qualified property’s basis, which is used in an enterprise zone. Qualified property is defined as depreciable tangible personal and real property, purchased new or used, that has not previously been used in Illinois and has a useful life exceeding three years.
Jobs Tax Credit—This credit is available for employers hiring eligible employees to work in an Enterprise Zone. The credit is $500 for each eligible employee hired to work in the zone during the tax year. To qualify, the employer must hire five or more eligible employees and increase by five or more full-time employees over the total employed in the zone during the previous year. Eligible employees must be: employed for 180 consecutive days, certified as eligible by the Department of Commerce and Economic Opportunity, hired after the Enterprise Zone was established and full-time employees working 30 hours a week or more.
Replacement Tax Investment Credit—This credit is available for businesses in manufacturing, retail/wholesale and coal or fluorite mining. This credit is equal to 0.5 percent of the qualified property’s basis. Qualified property is defined as depreciable tangible, personal and real property, purchased new or used, that has not been previously used in Illinois, with a useful life exceeding three years. An additional credit equal to 0.5 percent of the qualified property’s basis is granted if the business’ base employment in Illinois increased by one percent or more over the past year.
R&D Credit—This credit is available for businesses performing research and development activities in Illinois. The credit is equal to 6.5 percent for the excess of qualifying R&D expenses for the tax year over the qualifying expenditures over the base period. Qualifying expenditures are defined with reference to the federal R&D credit.
Summary
This is just a brief overview of some of the income tax credits which should be considered by businesses. There are several other credits available for different types of business activities, many aimed at various types of expenditures or types of businesses. Varying carryover provisions are provided for many of the credits if they cannot be fully utilized in the year of claim. Of course, all credits require certain record-keeping requirements to support the credit if examined by a taxing authority. Talk to your tax adviser to ensure that valuable dollars are not left on the table by not claiming credits that may reduce your income tax and increase your cash flow. IBI
