The PATH to Credits and Incentives
The PATH Act provides companies with more stability in terms of investment planning and may significantly impact the number and scale of future investments.
Today’s business world is largely built on competition. Most of us primarily associate it with businesses competing for clients and market share; however, recently, a different kind of rivalry has become more prominent — one that involves companies comparing sites for new investments or deciding whether to maintain operations in existing locations. This competition exists at different levels and involves assorted benefits — credits and incentives — offered by the competing parties to secure a favorable outcome. Which is why, similar to other countries, the U.S. offers prospective investors a wide array of potential benefits, some regulated at the federal level and others remaining at the discretion of state and local authorities.
The end of 2015 brought an important development for several federal credits and incentives: on December 18, President Obama signed the Protecting Americans from Tax Hikes (PATH) Act, effectively making some credits and incentives permanent, while extending others for additional years.
Work Opportunity Tax Credit
While increasing automation and mandatory wage increases may limit the motivation for adding new jobs in some industries, for many others, employees remain an integral element — and also one of the main cost positions. As businesses are always looking to maximize return on investment, optimizing labor costs continues to be one of the key reasons why companies decide to move operations overseas or utilize outsourcing. It is also why credits and incentives aimed at offsetting these costs, including the Work Opportunity Tax Credit (WOTC), are as relevant as ever.
The WOTC program was created to incentivize employers to hire and retain qualified veterans and individuals from target groups facing barriers to employment, including welfare and food stamp recipients and designated community residents. By hiring eligible individuals, an employer qualifies for the tax credit calculated on each employee’s target group, first-year wages, and number of hours worked. With the credit value amounting to between $2,400 and $9,600 per employee, for 1,000 annual hires, an annual credit of approximately $200,000 may be generated. Contributing to the bottom line and reducing the effective tax rate, WOTC continues to be an important incentive with employers collectively claiming about $1 billion of credit annually.
The PATH Act extended WOTC for an additional five years, retroactive to Jan. 1, 2015 through Dec. 31, 2019, with additional time to screen employees hired by May 31, 2016. It also introduced a new target group for the long-term (at least 27 weeks) unemployed. These individuals are eligible for tax credits from Jan. 1, 2016 onward. The extension creates an opportunity to claim tax credits for all businesses planning to increase headcount in the upcoming years, including both employers already familiar with WOTC and ones that have not utilized the tax credit so far. Knowing beforehand that the credit will remain in force until 2020, employers may plan their hiring needs more effectively and become proactive in employing individuals from the target groups. Between 10 and 40 percent of a company’s new hires may initially screen eligible for WOTC.
The WOTC program can be attractive to all industries (i.e., retail, restaurants, healthcare, financial, manufacturing, telecommunications, construction, professional services, and more). EY recently implemented WOTC for one of the largest staffing companies in the world by creating an integrated WOTC solution within their hiring systems for an efficient and effective process. This also resulted in increased WOTC performance measures and tax credits generated. In addition, EY implemented an automated solution that significantly increased the WOTC performance and compliance, as well as doubled the WOTC credits, for one of the largest U.S. pharmaceutical companies.
New Markets Tax Credit
With states and local authorities competing for investments by offering customized incentive packages, some areas in the U.S. persistently remain less developed than others, with high unemployment and poverty rates — which is why a special incentive scheme aimed at stimulating growth in less prosperous locations was introduced in 2000 in the form of the New Markets Tax Credit (NMTC).
NMTC is an instrument for attracting businesses to some of the most distressed communities by providing a federal tax credit for investments made in businesses or economic development projects in these communities. The credit totals 39 percent of investment costs claimed over seven years and is awarded not to the investor, but to Community Development Entities (CDEs). CDEs then use the proceeds to make community investments, including in businesses and real estate projects. Instead of a tax credit, a qualified business receives cash up front to reduce cash investment in its project, which may provide an estimated 15 to 20 percent pretax return on the investment. EY recently obtained a $16 million federal allocation for an Illinois client from the healthcare sector to finance equipment for the expansion of its facilities.
The NMTC program has been renewed by the PATH Act through 2019 with a set budget of up to $3.5 billion annually, thus making it possible for additional communities and businesses to benefit. The five-year extension, instead of annual renewals, provides businesses with more stability and allows for better planning in terms of new investments and their location. As a result, more companies may consider investing in eligible communities as NMTC creates significant cash flow savings and, combined with additional incentives offered locally, often creates incomparable investment conditions. Moreover, the next NMTC award round will provide a record $7 billion in allocation (combined budget for 2015 and 2016), which means increasing both the expected number of participating CDEs and the amount assigned to each of them to further invest.
The federal R&D credit is a nonrefundable tax credit that may be used by a business to reduce its federal tax liability on top of the 100 percent deduction allowed for R&D costs. Renewable Energy Tax Credits
While energy efficiency and sustainability remain high on agendas across different sectors, the high costs of renewable energy systems often limit the extent and value of investments. However, thanks to federal tax credits, investing in renewable energy enables businesses to combine the goal of becoming more sustainable while saving on energy costs and managing an effective tax rate.
The Investment Tax Credit (ITC) is aimed at businesses installing renewable energy equipment and technologies, including solar, geothermal, fuel cells, microturbines, combined heat and power systems, and geothermal heat pumps. The credit value amounts to either 10 or 30 percent, depending on the technologies used. While the ITC-eligible systems should be primarily used by their owner, for qualified renewable energy facilities, the Production Tax Credit (PTC) is available instead.
The PATH Act extended ITC and PTC for additional years at the current value with subsequent phase-out schedules and modified the expiration date for solar and wind technologies, which now depends on when the construction began instead of when the system was placed in service. Businesses will be also able to benefit longer from the 50 percent bonus depreciation, which was renewed through 2017. The latter, while not a renewable-energy–specific change, enables business to further lower effective investment costs, as a large part of renewable energy equipment is usually eligible. As a result, substantial opportunities for businesses to invest in renewable energy projects or to procure the output power they generate have been created. In the long term, the above measures are expected to continue to drive down renewable investment costs as more systems are sold and installed and additional businesses enter into power-purchase agreements.
One of EY’s green procurement clients, a multinational bank pursuing renewable energy procurement globally and in the U.S., will benefit from purchase agreements with pricing approximately 30 to 50 percent lower as a result of the PATH Act. This is due to the fact that renewable energy developers are able to monetize a PTC or ITC available for their projects and pass along the monetization benefits through lower power-purchase agreement pricing.
With the November elections coming up, it remains to be seen what the future of credits and incentives will be. While businesses often do not have a choice whether to invest in R&D, they may be quite selective when it comes to where they invest. And as R&D investments are considered prestigious, various incentives are offered worldwide to attract them. Taken together, competitive employment costs, lower tax rates, and other benefits make investing in R&D abroad appealing for both U.S. and foreign companies.
The federal R&D credit is a nonrefundable tax credit that may be used by a business to reduce its federal tax liability on top of the 100 percent deduction allowed for R&D costs. As it is intended to reward companies for increasing their R&D spend, its value depends on the increment compared to a base amount for previous years. The credit is applicable retroactively as well as to current investments and, if unutilized, may be carried back for one year and carried forward for 20 years.
Until recently, the R&D credit has always been a temporary provision. The permanent extension introduced by the PATH Act creates a more stable environment to plan for and to conduct R&D work and makes the U.S. an attractive location for R&D investments. Businesses now may be certain that eligible costs will qualify for the credit while mapping R&D projects in a multiple-year perspective without the uncertainty of whether the credit will be extended for another year. The PATH Act provisions also make it easier for eligible small businesses to utilize the R&D credit, as they may now claim it against their alternative minimum tax liability. In addition, small businesses with less than $5 million of gross receipts will be able to apply the credit against the employer’s payroll tax liability up to $250,000. Both concessions apply to companies that do not generate a lot of tax liability, and as such, they will be now able to reinvest the tax benefits in their further growth.
The PATH Act not only gives businesses additional time to claim select credits and incentives, but also provides more stability in terms of investment planning with regard to headcount, capital spend, R&D costs, and sustainability. As most businesses plan in three-to-five-year cycles, extending credits and incentives for a few years in advance (or permanently) may significantly impact the number and scale of investments that we will see in the upcoming years.
With the November elections coming up, it remains to be seen what the future of credits and incentives will be. As keeping jobs and investments in the United States is one of the few things both political parties and all candidates seem to agree on, improving existing and/or introducing new credits and incentives could be seen as the way to create attractive business conditions for domestic and foreign investors. Nonetheless, the PATH extension has given businesses more certainty until any further changes are introduced — whether for better or worse.
The views expressed are those of the author(s) and do not necessarily reflect the views of EY LLP.
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