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The Research & Development Tax Credit for Manufacturing and Distribution Companies

The R&D Tax Credit is one of the most beneficial tax credits available to manufacturing and distribution companies. Made permanent with the passage of the Protecting Americans from Tax Hikes Act of 2015, this non-refundable credit is available to businesses of all sizes and is designed to encourage the development of innovative and enhanced products, processes, and software in the United States. As both a federal and a Georgia credit, the R&D Tax Credit is one of the largest business tax incentives provided by the U.S. and state government.

The R&D Tax Credit is calculated at 20 percent of the excess of an eligible taxpayer’s qualified research expenses over a base amount. Qualified research expenses are comprised of all internal or contract research expenses paid or incurred by a taxpayer in carrying on trade or business. These expenses include (but are not limited to) salaries and wages, supply cost and M&D costs (i.e., manufacturing research). In order to qualify as a qualified research expense, the research activities have to be conducted on U.S. soil and they must pass a four part test outlined in the Internal Revenue Code (IRC §41). The base amount is determined in reference to the total qualified research expenses for the previous three years. The R&D Tax Credit is incremental in nature – meaning that in order to realize greater benefits from the credit, a taxpayer must increase their research expenses over time.

The Georgia R&D Tax Credit is available to any business that increases its qualified research spending in the state. Just as the qualified research expenses have to be incurred on U.S. soil to be eligible for the federal R&D Tax Credit, the qualified research expenses have to be incurred in Georgia to be eligible for the Georgia R&D Tax Credit. Whereas the federal credit can be carried back one year and forward twenty years, the Georgia credit can be carried forward ten years and is able to offset 50% of net Georgia income tax liability.

Often times, taxpayers do not realize that the work that they are doing is innovative and qualifies for the R&D Tax Credit. The activity does need not be an “innovative” and have an industry-wide impact – as long as the R&D work is related to improving your businesses products or processes, it may be a qualified research and development expense. It is recommended that all business involved in some type of research and development activities have a feasibility study to determine the amount of the possible federal and state credits available to them. The credit can be taken for all open tax years. Thus, the tax benefits of conducting a research and development credit feasibility study and a R&D Tax Credit study could be tremendous and help to generate enormous tax savings over several years.

If you believe that your business is conducting some research and development activities eligible for either the federal or Georgia credit, HLB Gross Collins, P.C. can assist you.  HLB Gross Collins, P.C. has been serving some of the Southeast’s most prominent manufacturing and distribution companies for nearly 50 years.  Our M&D Practice works closely with the clients to ensure that they are taking advantage of all available credits and savings opportunities.

August/September Dates to Remember

August 10

Employers. For Social Security, Medicare, and withheld income tax, file Form 941 for the second quarter of 2017. This due date applies only if you deposited the tax for the quarter in full and on time.

August 15

Employers. For Social Security, Medicare, withheld income tax, and nonpayroll withholding, deposit the tax for payments in July if the monthly rule applies.

September 15

Individuals. If you are not paying your 2017 income tax through withholding (or will not pay enough tax during the year), pay the third installment of your 2017 estimated tax. Use Form 1040-ES.

Employers. For Social Security, Medicare, withheld income tax, and nonpayroll withholding, deposit the tax for payments in August if the monthly rule applies.

Corporations. Deposit the third installment of estimated income tax for 2017. Use the worksheet Form 1120-W to help estimate tax for the year.

Partnerships. File a 2016 calendar year return (Form 1065). This due date applies only if you timely requested an automatic six-month extension. Provide each partner with a copy of his or her final or amended Schedule K­1 (Form 1065) or substitute Schedule K­1 (Form 1065).

S corporations. File a 2016 calendar year income tax return (Form 1120S) and pay any tax due. This due date applies only if you timely requested an automatic six-month extension. Provide each shareholder with a copy of Schedule K-1 (Form 1120S) or a substitute Schedule K-1.

College Costs are on the Rise – Again

The College Board reports that the average published charges for tuition, fees, room, and board at private, nonprofit, four-year schools were over $45,000 in the 2016–17 academic year. At public universities, the average charge was around $20,000 for state residents. Both numbers are the highest on record.

Such expenses for higher education are daunting, but the reality may be less onerous. Many collegians receive some form of financial aid that brings down the actual cost. The College Board also reports “net” prices, estimating the true cost of a year in college after recognizing financial aid and the savings from certain education-related tax benefits.

For the 2006–07 academic year to 2010–11, net prices declined in constant 2016 dollars. Even as published prices continued to rise, the average net price at private colleges fell from $24,580 to $23,620.

Since then, however, net prices have begun to move up. In 2016–17, the average figure at four-year private colleges reached $26,080. In-state students at public universities saw average net prices hold steady in the $11,000–$12,000 range from 2006–07 to 2010–11, but shoot up to $14,210 in 2016–17. In recent years, increases in grants have not kept up with rising published prices, creating more expensive net prices for higher education.

For parents of collegians and younger students, the message is that they may have to put more effort into competing for college grants. Some strategies for dealing with the Free Application for Federal Student Aid (FAFSA) can be found here. Savvy investing of college funds can also help; click here for suggestions on how to manage 529 college savings accounts.

Summer is FAFSA Prep Time

The “new” FAFSA schedule (introduced in 2016) makes summer the time for FAFSA prep. On October 1, 2017, financial aid applications for the 2018-19 school year can be filed. In prior years, students had to wait until January 1 to request financial aid for the coming academic year.

Why is this important? Some observers believe that financial aid may be granted on a first come, first served basis, so the early filer may have more of a chance to receive aid. Also, filing a FAFSA early may increase the chance for merit (not need-based) aid because some colleges require the FAFSA for such grants.

In addition, FAFSA will now have real family income numbers from federal income tax returns, rather than estimates.

Example 1: Mark Thompson will start college in the fall of 2020. In October 2019, Mark can file the FAFSA. He’ll use his family’s income from 2018 based on the tax return filed in 2019. (Even if Mark’s family gets a filing extension from April 15, 2019, the return must still be filed by October 15 of that year, so the 2018 income numbers will be available for a FAFSA filing in October 2019.)

Under the previous FAFSA schedule, Mark would have filed the FAFSA in early 2020, using estimated income numbers for 2019. Then, he would have amended the FAFSA, if necessary, to conform with the actual 2019 numbers. That won’t be necessary now that the Thompsons’ 2018 income will help determine Mark’s need-based aid in the 2020-21 school year.

Planning far ahead

Under the new FAFSA schedule, planning for college funding should begin much earlier, probably in the ninth or tenth grade. Income from the calendar year that includes the student’s sophomore and junior years of high school will be the income that shows up on the first annual FAFSA filing.

Example 2: Mark Thompson, who will start college in the second half of 2020, will be a tenth grader in the first half of 2018, and a high school junior in the second half of the year. The family’s income from that year will be the income reported on Mark’s first annual FAFSA and, thus, will determine financial aid when Mark goes to college.

Therefore, if Mark’s parents are planning actions that would increase income, they might want to do so in 2017, when Mark goes from the ninth to the tenth grade. Such actions could include taking capital gains, taking retirement plan distributions, or converting traditional IRA dollars to a Roth IRA. Acting before January 1 of the sophomore year of high school will keep the resulting income from the FAFSA. Alternatively, such actions might be postponed until January of the student’s sophomore year of college, or later, when the income may no longer show up on a FAFSA filing.

Reducing the assets reported on a FAFSA also may increase aid. Parents might fund an IRA in the current year, moving cash into retirement accounts that are not counted in determining the expected family contribution to college costs. IRA contributions for 2018 can be made until April 15, 2019, but contributing in early 2018 can reduce reported assets on a subsequent filing.

In some cases, a business owner might want to consider changing the choice of entity during the FAFSA years. Many small businesses are S corporations, which avoid the corporate income tax. However, an S corporation passes through all income to the company’s owner, and a high income could reduce financial aid. With a regular C corporation, the company’s income doesn’t pass through to the owner. Our office can help you weigh all the pros and cons of C corporation versus S corporation status, including the impact on college aid.

Grandparent strategy

The new FAFSA schedule also affects planning for 529 college savings plans that are owned by grandparents, with a grandson or granddaughter as the beneficiary. The assets of such a 529 plan are not reported on a FAFSA, so they don’t reduce possible financial aid. However, when grandparent-owned 529 plans distribute funds to cover college costs, the payouts count as untaxed income to the student on a FAFSA, which can reduce aid eligibility substantially.

Now, grandparent-owned 529 plans can hold onto their assets until January of the student’s sophomore year. Tax-free distributions for educational expenses may be able to begin then without showing up on a FAFSA to affect financial aid.

FAFSA Facts

• There is no upper limit on family income to qualify for federal student aid.
• Eligibility for aid is determined by a mathematical formula, not by family income alone. Besides income, many factors (such as family size and parents’ age) are taken into account.
• The higher the cost of attendance at the chosen college, the more aid that may be offered.
• Having more than one child in college at the same time will increase the chance for financial aid.
• A student who fills out the FAFSA automatically applies for funds from his or her state as well as from the federal government, and possibly from the school as well.
• Some schools won’t consider students for any of their scholarships (including academic scholarships) until they have submitted a FAFSA.

College Savings: Why 529 is the Magic Number

Parents with young children have two broad choices when investing for higher education. One is to invest as you did before you had children, with assets in taxable and tax deferred accounts, under your own names. This will give you maximum flexibility in terms of investment choices and tax planning. When the time comes, you can peel off assets to pay college bills. (Financial advisers may advise against tapping retirement accounts to pay for college.)

The other approach is to have a dedicated college fund, or one college fund for each student. One advantage of this method is psychological; you may be reluctant to use higher education money for a cruise or a luxury car lease.

In addition, a dedicated college fund has a compressed time horizon. When the child is in his or her late teens and early twenties, the money will be needed. If the portfolio value has dropped sharply before and during those years, there may not be enough time to recover losses, let alone continue to grow.

Why 529 is the magic number

For parents and grandparents who prefer a dedicated college fund, 529 plans—named after a section of the tax code—are increasingly appealing. Over $275 billion is invested in these plans, mainly in college savings plans that are similar to 401(k) retirement plans in that account holders choose from a menu and enjoy untaxed investment income. (Some 529 plans are prepaid tuition plans, which operate differently.)

Unlike 401(k)s, 529 plans are largely funded with after-tax dollars. As an offset, all 529 withdrawals can be tax-free, whereas 401(k) distributions are taxable. To qualify for tax exclusion, 529 withdrawals must not exceed the amount spent on qualified higher education costs, which generally include tuition, fees, room, and board.

Age-old question 

The holders of 529 accounts face a dilemma when it comes to investing. To make the most of the benefit of tax-free distributions, 529 plans should be invested for growth. The tax savings from an account that has gained, say, 2% a year will be much less than the tax savings from a 529 account in which growth has been 7% or 8% a year.

On the other hand, for a 529 account to grow rapidly, investors must put money into volatile assets, such as stock funds. That brings the risk of poor timing; your student might enter college after a bear market has depleted the 529 account, which could leave your student with a smaller college fund.

Investment professionals may suggest a “glide path” strategy to address such concerns. For a young child who is 10, 15, or even 18 years away from high school graduation, 529 money might be invested mostly in equities with a hope for strong growth. As college nears, the asset allocation can shift from stocks to bonds and cash. Some observers assert that a 529 account should be very light (perhaps less than 10%) in equities by the time of college admission, minimizing risk, whereas others suggest a somewhat larger position in stocks for continuing growth potential.

Packaged portfolios

Parents who like the idea of a glide path can choose from a 529 plan’s menu. Every year or so, move money from aggressive to more conservative investment options.

If you don’t feel up to such maneuvers, or just prefer not to be bothered, don’t fret. “Age-based” portfolios usually are offered to 529 investors. Essentially, these portfolios are on autopilot so that your child’s 529 account will become more conservative over time.

Nevertheless, an age-based portfolio in one state’s 529 plan may be much different from another state’s. Before signing up, look at the details carefully. Are you comfortable with the underlying asset allocation and the way that allocation will shift? There may be multiple options to consider within one state’s plan, as well as from different states. Make sure you know just how your college fund will be managed.