2013 - Issue 20—There are thousands of tax credit and incentives programs in the United States, sponsored by federal, state and local governments. These programs drive job creation, employee training, capital investment and new business development and are available to companies of all sizes and across a broad range of industries. However, recent studies have shown that a relatively small number of companies, regardless of their size or financial sophistication, are fully benefitting from the tax credit and incentive-related benefits to which they are entitled. With the forecast for expansion and growth in capital expenditures over the next several years, taxpayers should take a closer look at how federal, state and local incentives can help fund their continued growth.
This article provides taxpayers with additional insight into the opportunities, issues and approaches that can be applied to maximize their current tax credits and incentives program. The following discussion addresses basic forms and types of incentives, recent trends in credits and incentives, and best practices for managing a tax incentive program.
The Basics — Types of Credits and Incentives
As the name implies, a tax incentive is designed to incentivize, or encourage, a particular economic activity using favorable tax positions as the catalyst for the activity. The federal tax code provides a wide range of incentives for corporations, totaling $109 billion in 2011 according to a Tax Foundation study. Similar incentives are offered by most state and local jurisdictions. The amount and form of the incentives can vary greatly, so it is important that a taxpayer understand which incentives bring the most value in order to prioritize the invested time and resources.
In general, tax incentives have two basic types — statutory and negotiated. As the name implies, statutory credits and incentives have their basis in a statute or regulation. If a taxpayer meets the qualifications as set forth in the law, the taxpayer is eligible to receive the credit. The type and amount of statutory incentives are objectively defined and generally can be obtained solely by qualifying under specific criteria.
Federal incentives are generally statutory. Federal incentives can be in the form of accelerated deductions (e.g., bonus depreciation), reduced exclusions (e.g., exceptions to the meals and entertainment exclusions), permanent deductions (e.g., Section 199 deduction) and tax credits. Examples of some of the more popular federal statutory tax credits include the Research Tax Credit, the Work Opportunity Tax Credit (WOTC) and New Market Tax Credits. Frequently, state and local incentives piggy-back the federal provisions, but careful analysis should be done to confirm how closely a state follows the federal requirements.
State and local governments can offer both statutory and negotiated incentives. Negotiated incentives are typically directly linked to a specific corporate development project. These incentives, which may be offered by state economic development agencies or state and local jurisdictions, require a case-by-case analysis. The discretionary nature of the incentives allows both the government and the taxpayer to negotiate the amount and type of incentives that are most beneficial to them.
A major factor in obtaining negotiated incentives is the perceived value of the project to the community. This may be objectively demonstrated by the number and salary levels of jobs retained, increased or attracted, or by the amount of direct and indirect tax revenues generated by the operations of the project. Subjective factors may also be considered, such as the strategic value of a benefited company or project.
Many state business development agencies have grown to favor negotiated incentives rather than statutory programs because they give the government more flexibility in targeting limited resources towards industries or companies that are most important to a community. Timing is critical for discretionary credits. In most cases, negotiated incentives are available only if it can be shown that the project would not have proceeded without the incentives. Companies looking to expand should approach the appropriate economic development, commerce or energy department as early as possible to begin the negotiation process. A potential downside for a taxpayer is that the government may be able to enforce clawback provisions if businesses fail to comply with the terms of the agreement.
Whether the incentive is statutory or negotiated, not all incentives have the same value to a taxpayer. Federal and state governments employ diverse financial tools to compete for corporate location decisions. The tax benefits may be available to offset corporate income tax, sales and use tax, or property tax, or be a deduction. The incentives may also include non-tax features such as grants, low-rate financing or donated land. It is important that companies understand which form of incentive is most valuable to them.
Companies with large net operating losses likely will not value accelerated deductions as much as they would refundable credits or benefits tied to non-income taxes such as sales and use or property taxes. Companies with net operating losses, or that are otherwise unable to use available tax credits, may benefit from programs currently offered in more than 30 states with opportunities to monetize tax credits through refunds and sales.
Recent Trends in Credits and Incentives
In general, the statutory opportunities offered by the federal and state governments fall into four major categories:
- Workforce (human capital) incentives — targeted toward groups who have consistently faced substantial barriers to employment, such as veterans, Native Americans, food stamp recipients and residents of designated communities.
- Location or geographic incentives — to attract job creation and investment in distressed areas. Location-based incentives may be available as a result of employing individuals who reside within defined geographic areas without increasing workload or headcount.
- Investment incentives — to encourage investments in qualified capital projects (project buildings and machinery and equipment).
- Activity-based tax incentives — to encourage specific types of business activities, including manufacturing, high technology or R&D activities.
Given recent high unemployment levels, job creation has been a particular area of focus for incentives programs during the last couple years.
Creating an Effective Credits and Incentives Process
Tax incentives should be viewed as a source of investment funding. There are a number of reasons why companies fail to maximize their incentive opportunities. Most taxpayers commonly point to three key reasons for not taking full advantage of tax credits and incentives:
- Tax credits and incentives are too complex to identify, manage and administer.
- The available incentives are not substantial enough to be worth the filing effort or the impact on their core business impact.
- The tax department does not have the internal resources to adequately monitor and maintain the incentives.
The complexity of tax credit and incentive programs is particularly great on the state and local level. All 50 states offer a myriad of programs, with credits driven by a company's investment levels, headcount and business activity at each location. For companies operating various locations in multiple states, the identification, application process and ongoing management of these programs is no simple task. It is essential to prioritize the opportunity areas based on the type and amount of potential benefits.
Five key steps can serve to re-focus attention on identifying, capturing and managing the relevant incentive opportunities.
1. Develop and maintain a trigger list:
The first step in identifying credits and incentives is the creation of a trigger list that will help the business know when the tax department should be contacted because incentives may be available. The trigger list is intended to identify specific conditions and events that serve as key reasons to explore tax credit and incentive opportunities. These trigger lists should be reviewed with the applicable groups throughout the organization to ensure that the tax department is aware when a trigger occurs.
For example, in the human capital category, triggers may include increases or decreases in employment, turnovers, relocations, employee training or retraining, and shifts from contract-based to permanent employment status. Facility and production-related triggers include new capital investment, new or renewed leases, building or property acquisitions, facility upgrades, consolidations and closures, mergers and acquisitions, changes in production mix or schedule, or relocation of equipment. Similar triggers may exist based on the type of activity performed by a group (i.e., R&D, software development or production activities).
2. Know the types of credits and incentives that create the most value:
Not every incentive is created equal. Federal and state tax positions may be very different, so it is important to understand the company's tax profile in all major jurisdictions. It is critical that a taxpayer understand which forms of incentives will be most valuable based on the company's current financial status and fiscal priorities. It is necessary to analyze all factors that may influence the value and usability of potential incentives, including sufficiency of tax liability to fully utilize tax credits, performance obligations and covenants, the need for flexibility to accommodate future uncertainties, and related factors. This information will enable the project team to make well-informed decisions about which programs to pursue, which also will focus the scope of work going forward.
3. Engage non-tax areas of the company to help drive credits and incentives:
In today's business environment, most corporate tax departments, regardless of size, have neither the time nor expertise to monitor all of the potential tax credit programs. This is particularly true if the business operates in multiple states and is decentrally managed. Because most tax incentives require interaction with non-tax areas of the organization, it is important to engage these areas early and often so they understand the benefits that are available and how they can assist with the process. These non-tax areas are generally in the best position to gather the required information, and tax departments should try to leverage these areas as much as possible.
For example, the human resource department is more than likely the group that will be most valuable in gathering documentation for the workforce category of credits discussed above. The tax department should work with HR to create a simple questionnaire to gather key employee factors that may be relevant to the tax credit. If at all possible, the questionnaire should be automated to ease its use. The most successful companies require that every new employee complete screening forms to allow scoping for eligibility.
The business development teams (and other groups tasked with leading expansion or capital improvements) are one of the most important areas with which to build relationships. A dialogue with these groups is important, so they understand the types of incentives that are available and what the tax department needs to identify and support the incentives. It is critical that the business development teams understand the importance of timing. Recognition of the contributions of the non-tax groups is critical to future success.
4. Create a process to continually evaluate available incentive programs:
Tax credit and incentive programs are constantly changing. It is important to diligently keep abreast of new opportunities on the federal, state and local levels by developing a formalized monitoring process. It is generally not realistic to have a person dedicated to monitoring and tracking new programs on a daily basis, so it helps to make it a regular part of the tax calendar process. Quarterly focused reviews are generally as effective as daily monitoring. The focus of the review should be to understand applicable statutory incentives, the timing to receive benefits and the basic type of information that's required to claim the incentives.
It is very helpful to engage a senior level corporate champion, such as CEO, CFO, Treasurer or VP Tax. Companies that have an effective tax credit and incentives program are usually those that have made oversight and management of this area a priority. It requires the identification of the necessary internal or external resources (whether they are inside or outside tax) and the establishment of a formal program to track and monitor the activities.
5. Understand and document ongoing administration:
A tax incentive program will be of little value if the benefits are lost because required paperwork is not maintained. Necessary documentation should be tracked on the front end, and a calendar should be developed for future tax reporting requirements. While statutory incentives may appear on their face to be simple and easy to use, in practice they are often subject to unanticipated pitfalls and strict statutory interpretation that may limit the potential benefit. The tax department needs to understand what type of documentation is required to support the incentives, and to monitor the documentation to make sure it is being properly maintained. Incentive deadlines should be added to tax calendars along with other reporting requirements. Early notification should be requested in the case of corporate development efforts.
Alvarez & Marsal Taxand Says:
Regardless of the type of incentive at issue, the process used to identify and manage tax incentives should be similar. The planning should be forward thinking and understand what incentives are of most value to a company. An effective incentives program cannot stop at the tax department and must carefully integrate activities with other key areas of the organization. Incentives planning should be incorporated with multiple groups throughout a company.
When carefully managed, a company's tax incentives program can be a profit center that helps fund future growth. The key is to understand what programs are available and what information is required to take advantage of the programs, and then to implement procedures that allow for continued tracking of opportunities. If management understands the value of an incentives program, it will be easier to engage internal and external resources to assist with the process. At the end of the day, the business operations must be the driver, but tax credits and incentives should be a critical component in any investment decision-making process.
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