Lower Your Effective Tax Rates with Specialty Tax Incentives
Numerous business tax incentives are available to taxpayers for the achievement of economic goals. In general, these tax incentives are combined into one ‘general business credit’ for purposes of determining each credit’s allowance limitation for the tax year. The general business credit that may be used for a given tax year is limited to a tax-based amount. In general, the current year’s credit that cannot be used in a given year because of the credit’s allowance limitation may be carried back to the tax year preceding the current year and carried forward to each of the twenty years following the current year before any unused credits would expire unutilized.
Some of the more common specialty tax incentives include:
- The R&D Tax Credit for Increasing Research Activities
The R&D Tax Credit is available for companies that incur Qualified Research Expenditures (Wages, Supplies, Contracted Research) to develop new products, enhanced products, or manufacturing processes improvements within the United States. The R&D credit was enacted in 1981 to help bolster the United States economy during a daunting recession. The R&D credit has been a highly successful program over the past forty plus years and counting.
- The Orphan Drug Tax Credit (“ODC”)
The ODC provides a credit for qualified clinical trial expenses relating to ‘orphan drugs’ (i.e., specific drugs intended to treat rare diseases or conditions that are designated as such by the FDA). For years beginning on or after January 1, 2018, the ODC rate is reduced to 25% of such amounts and taxpayers may consider a reduced credit election. Like the R&D tax credit, the deduction for ODC expenditures under Section 174 must be reduced by the entire amount of the ODC credit unless an election is made on Form 8820 to reduce the amount of the credit.
- The Work Opportunity Tax Credit Program (“WOTC”)
A WOTC is available through 2025 for qualified wages paid to certain types of workers. ‘Qualified’ wages generally are the first $ 6,000 of wages paid to each qualified employee for the year. The credit is a general business credit equal to 25% of qualified first-year wages for employees who worked at least 120 hours but fewer than 400 hours, and 40% of qualified wages for those working 400 hours or more, for a maximum credit of $ 2,400 per qualified employee. Additionally, qualified tax-exempt organizations may claim the WOTC as a credit against payroll taxes for hiring qualified veterans.
In addition to tax credits, there are additional programs designed to accelerate deductions including cost segregation analysis and bonus depreciation.
- Cost Segregation & Bonus Depreciation to Accelerate Component Depreciation
Cost Segregation is a highly advantageous tax planning strategy that allows companies and individuals who have either constructed, purchased, inherited, expanded or remodeled any kind of income producing real estate to increase cash flow by accelerating depreciation deductions and reducing federal income taxes. To supplement accelerated depreciation deductions, bonus depreciation is also used to maximize tax savings. An engineered-based cost segregation study identifies and reclassifies real property assets into personal property assets to shorten the depreciation time, which accelerates depreciation expense and reduces current income tax liabilities. Personal property assets include a building’s non-structural elements, exterior land improvements and some indirect construction costs. The primary objective of a cost segregation study is to identify all construction-related costs that can be depreciated over a shorter tax life than the building itself. Personal property assets found in a cost segregation study generally include items that are affixed to the building but do not relate to the overall operation of the building. Land improvements generally include items located outside a building that are affixed to the land. They include parking lots, driveways, paved areas, site utilities, walkways, sidewalks, curbing, concrete stairs, fencing, retaining walls, block walls, car ports, dumpster enclosures, and landscaping. Shortening tax class lives results in accelerated depreciation deductions, a reduced tax liability, and increased cash flow.
In contrast, bonus depreciation is an accounting method that allows taxpayers to write off a percentage of the cost of specific assets in the year the property is placed into service. The purpose of bonus depreciation is to encourage taxpayers to invest in new property, plant, and equipment-based assets. While the rules change yearly, bonus depreciation is currently available for both new and used equipment. The amount you can write off depends on the type of asset. To claim bonus depreciation on a tax return, businesses must meet certain requirements under the tax laws. For instance, the asset must be placed in service by the business. So, if a taxpayer purchased new equipment in 2022, but the asset is not placed into service until 2023, the taxpayer would not be eligible for bonus depreciation in 2022. However, the taxpayer would be eligible to take bonus depreciation in 2023 when the asset is placed into service. Currently, you can only use bonus depreciation on assets that typically use MACRS depreciation with less than a 20-year class life. This includes all personal property (3-, 5-, or 7-year property) and land improvements (15-year property). The tax laws govern the amount of bonus depreciation that a taxpayer can take in any given year, which is subject to change. For example, in 2022, the maximum amount of bonus depreciation that a taxpayer could take was 100%. Bonus depreciation will phase out over the coming four years, dropping to 80% in 2023, 60% in 2024, 40% in 2025, and 20% in 2026. After 2026, bonus depreciation will sunset out and no longer be available.
