Federal Tax Credits Can Provide Tax and Cash Savings

May 2021

BY

Dan Fuller, Managing Partner, National Business Incentives & Tax Credits Practice Leader

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Tax credit programs provide opportunities to reduce tax expense, increase after-tax income and improve cash flow. The federal government offers a variety of tax credits and other incentives to encourage employment and investment, often in targeted industries or areas such as innovation and technology, renewable energy, low-income communities and others. Many states and localities offer their own tax incentive programs.

Taxpayers that are looking for ways to reduce their tax bill and boost their bottom line may still be able to take advantage of federal tax credits or incentive programs in 2021. In some cases, taxpayers also may still be able to claim benefits for prior years.

Federal tax credits and incentives to consider include:
 

Employee retention credit

The employee retention credit (ERC) is a refundable payroll tax credit for wages paid and health coverage provided by an employer whose operations were either fully or partially suspended due to a COVID-19-related governmental order or that experienced a “significant” reduction in gross receipts as compared to 2019. Businesses may use ERCs to reduce federal payroll tax deposits, including deposits of employee FICA and income tax withholding.
  • Eligible employers may claim a credit of up to $7,000 per employee in each quarter of 2021 (eligible start-up businesses can claim up to $35,000 per employee per quarter).
  • For 2020, the annual per-employee credit is limited to 50% of up to $10,000 of wages, or $5,000.
  • Businesses that have obtained a loan under the Payroll Protection Program (PPP) may also claim the ERC, provided that ERC wages are not also used for determining the amount of their PPP loan forgiveness.

Employers should take steps now to make sure they are claiming all of the ERCs to which they are entitled. Businesses that were eligible for but did not claim the ERC in 2020 may be able to file amended payroll tax returns to claim 2020 benefits. Importantly, planning may be needed prior to filing PPP loan forgiveness applications to ensure maximum benefits of both the ERC and PPP programs. BDO’s ERC resource hub contains more information on how to qualify for, calculate and claim ERC benefits. Also, be sure to review the update of guidance issued in April 2021 by the IRS—see BDO’s article IRS Issues Guidance for Claiming Employee Retention Credit in 2021.


 

 

R&D credit

Businesses in any industry are eligible for the federal R&D credit provided they incur expenses related to qualified R&D activities. Both in-house and contract research expenditures can qualify. Special rules apply for start-ups and qualified small businesses, which may be able to claim a credit of up to $250,000 against the employer portion of federal payroll taxes. Many states also offer their own R&D credits. R&D credits can reduce taxes by as much as 9% of qualified spending for federal taxes and as much as 40% in some states. 

For more information on the R&D credit, see BDO’s R&D Tax Credit FAQs for Large and Small Businesses, as well as information specifically for the manufacturing, technology, life sciences and healthcare industries. BDO’s R&D Tax Credit Calculator can assist businesses in estimating their potential R&D credit, including whether a business already claiming the credit is receiving the maximum benefit possible.


 

Incentives for investment in low-income communities

Qualified opportunity zones

Qualified opportunity zones (QOZs) present an opportunity for investors to defer (and potentially reduce) the federal tax due on certain capital gains. To qualify, a taxpayer must invest the capital gain in property or businesses located inside a QOZ, or in a “qualified opportunity fund” (QOF), shortly following the completed transaction that gave rise to the gain. (QOFs are investment vehicles that invest at least 90% of their capital in QOZ properties and businesses.) There are substantial tax benefits for investors:
  • Tax deferral on capital gains until the earlier of the disposition of the investment in the QOZ/QOF (or other inclusion event), or December 31, 2026;
  • Ten percent reduction of the deferred tax on the original gain when the investment in the QOZ/QOF is made by December 31, 2021 and is held for at least five years; and
  • Exemption from tax on post-acquisition appreciation of the QOZ/QOF investment provided the investment is held for at least 10 years and is sold by December 31, 2047.

More information on the rules for QOZs and investors can be found in BDO’s article Discussion of the Opportunity Zone Program Including Final Regulations.
 

New markets tax credit

The new markets tax credit program provides federally funded tax credits for approved investments in low-income communities that are made through certified “Community Development Entities.” The credit generally equals 39% of the investment and is paid out over seven years.


 

Energy efficiency and sustainability incentives

There are a number of federal tax benefits available for investments to promote energy efficiency and sustainability initiatives, including:
  • A deduction of up to $1.80 per square foot for investments in qualifying energy efficient systems (lighting, HVAC, etc.) installed in commercial, certain multi-family and government-owned buildings;
  • A credit of $2,000 per home for the construction of energy efficient new homes;
  • A credit of up to 26% of qualifying investments in solar, wind or other renewable energy equipment (the credit reduces further in 2023). Larger credit amounts may be available based on when the projects commenced construction and the application of the IRS regulations around this area;
  • Cash grants for the development of products and technology that assist with energy efficiency and certain other sustainability goals; and
  • Alternate fuel tax incentives.

Federal certification requirements apply in some cases. Many states also offer similar incentives.


 

Other credits for employers

Employers may be able to take advantage of the following credits:
  • The work opportunity tax credit (WOTC) program grants tax credits (of up to $9,600 per new hire) to employers that hire and retain individuals from any of 10 targeted employment groups—including veterans, ex-felons, long-term family assistance or unemployment recipients, summer youth workers and others.
  • Businesses operating within a federal empowerment zone may claim a 20% credit on up to the first $15,000 of wages paid to certain employees.   
  • The Indian employment credit may entitle an employer to a 20% tax credit on a portion of the qualified wages and employee health insurance costs paid to an enrolled member of an Indian tribe. (BDO’s article Three Tax Credit Opportunities Extended: WOTC, Federal Empowerment Zone and Indian Employment Credits contains more information on these three credits.)
  • The family and medical leave (FMLA) tax credit provides employers a credit of up to 25% of paid family and medical leave taken as a result of the birth of a child, adoption or foster care, or to care for a spouse or child that has a serious health condition.
  • The “FICA tip credit” gives tax relief to employers via a federal income tax credit that is based on the amount of FICA and Medicare taxes they have paid on reported tips.
  • Credits may be available for providing access for disabled individuals or for providing employer provided childcare facilities and services.


 

American Jobs Plan

The American Jobs Plan, introduced by President Biden on March 31, 2021, includes proposals that would create a number of new tax credits for businesses, such as credits for green energy initiatives, affordable housing, construction of childcare facilities and others. For more information on the American Jobs Plan, see BDO’s article Biden Administration Unveils Tax Blueprint as Part of American Jobs Plan.


 

How BDO can help

BDO professionals are experienced in helping businesses and individuals identify, substantiate, and defend tax credits and other valuable incentives. To learn more about BDO’s Business Incentives and Tax Credits services, contact BDO.