MGO CPA | Tax, Audit, and Consulting Services

Topic: Tax Incentive

Keys to Avoiding IRS Red Flags with Tax Credits and Incentives 

Tax credits and incentives are an often underutilized, yet powerful tool to help you improve your bottom line and reinvest in your business – all while substantially reducing your tax exposure.

In recent years, a number of firms have emerged specializing in credits and incentives and building large businesses by over-promising and under-delivering these tax consulting services. While credits and incentives are enticing, they must be handled with extreme care, as the consequences of getting it wrong can be serious.

At MGO, we not only help you determine if you are eligible for these valuable tax credits and incentives, but we also perform damage control and clean-up following bad actors’ broken promises and sloppy work. We have seen firsthand the fallout from their poor performance and how it affects clients. In this article, we will help you understand what to look for in a tax credits and incentives provider and recognize and avoid IRS red flags so you can safely capitalize on these opportunities.

An overview of tax credits and incentives

Designed to encourage investment and development, job creation, growth, and certain business activities, tax credits and incentives provide an opportunity to reduce the amount of tax owed for performing certain activities. Credits and incentives are categorically different than tax deductions, which reduce the amount of taxable income.

These incentives often target desirable industries or activities like research and development, job creation for at-risk populations, and expanded growth in underdeveloped areas. When leveraged correctly, credits and incentives can be a powerful tool to funnel back resources into your organization to fuel activities you are already doing. Even more enticing, these credits can often apply retroactively if you determine you qualify for certain credits or incentives after the fact.

There are three basic types of tax credits: nonrefundable, refundable, and partially refundable. Here, we break down just a few of the different types of tax credits pertaining to businesses in different classifications, industries, or activities performed:

R&D Tax Credits

Designed to incentivize innovation, this dollar-for-dollar tax savings has both Federal and State-level implications and can save you up to 15% on qualifying activities. To claim an R&D tax credit, your company must pass a four-part test and be involved in the technical development of new or improved products or processes. This can apply to product enhancements, product development, software development, process improvements, and more.

Employee Retention Tax Credit

The ERTC was created to provide much-needed financial relief for businesses affected by the COVID-19 pandemic. With complex eligibility requirements, the refundable tax credit awards qualifying employers with a payroll tax credit of up to $26,000 per employee as an incentive to retain them on payroll through potential closures, quarantines, and other hardships. Since its rollout, the ERTC has been expanded to continue providing relief to an even larger group of employers, even retroactively (albeit with a smaller maximum amount per employee for 2021).

IRC Section 179D

This popular tax incentive gives designers, builders, and building owners the opportunity to obtain a tax deduction of up to $1.80 per square foot if they install eligible energy efficient buildings and systems that reduce the power and energy costs by 50% or more compared to the minimum standard requirements. Tenants are eligible if they make the construction changes, and the deduction can be claimed on both retrofits and new construction projects. Buildings that qualify include commercial buildings like parking garages and warehouses, government-owned buildings like universities and libraries, and apartment buildings with four stories or more.

Work Opportunity Tax Credit

A federal tax credit for employers looking to invest in American job seekers who face barriers to acquiring employment, the WOTC is claimable if the employer 1) meets their business needs, and 2) does so by hiring an employee from a WOTC targeted group (which include veterans, ex-felons, and qualified long-term unemployment recipients, among others). An employer interested in claiming this credit must verify the new hire is a member by applying and receiving a certification.

Risks associated with claiming tax credits and incentives

While there are many benefits to tax credits and incentives, there are a few risks attached to claiming them on your tax return.

One risk is exposing your organization to an IRS audit. An audit does not always mean trouble — at least, not if you are doing everything right — but having to go through the process of complying means you are devoting time and effort to something that yields no financial value, ultimately draining resources from more conducive business activities. Working with IRS representatives and organizing and submitting documentation is labor-intensive.

A significant issue to note is that if you overstate your credits, the IRS’s software may flag the subsequent higher score for the return, sparking an audit — so claim succinctly and accurately. Then, of course, there is the issue of an audit exposing issues unrelated to your tax credits, making you vulnerable to even bigger problems.

Another risk is payback. Tax credits do not have payback requirements, but some tax incentives do, and along with them come penalties for failing to pay in a timely manner. You may also then accrue interest, which can add up quickly. This negates the incentives in the first place, only causing a bigger headache.

Red flags to look for in tax credit and incentive providers

To maximize the potential of the credits, working with a certified public accounting (CPA) firm is absolutely essential. Non-CPA firms do not have to adhere to strict accounting guidelines. Additionally, they may not have the requisite experience or perspective to assess your situation holistically. A trained and licensed professional will examine your operations, uncover missed opportunities, and help you capitalize on a lower tax liability. But choosing unwisely can have major ramifications and increase your chances of being audited by the IRS.

Here are some of the most important red flags to look for when selecting a provider:

1. Standalone tax credits and incentives firm

Firms that do not utilize CPAs often use lower-cost, less-experienced recent graduates who act more in a sales-focused capacity than as an accountant. This lack of knowledge and background in accounting fundamentals can result in you being misled by someone who is not equipped to help with complex tax matters.

2. They only take contingency-based payments

Stay away from firms that take 25-35% of the savings recouped in fees. This is a sales approach that is commission-based by maximizing your credit, and you can assume they are being incentivized by these fees to over-promise — which means they will almost certainly underdeliver. Another negative? If an auditor sees your tax provider takes contingency-based payments, they will automatically assume they are acting in bad faith and then comb through your past credits to verify their accuracy. And they can look through your last three tax returns, making you even more vulnerable.

3. They market a team of “experts” with IRS or legislative backgrounds

Look out for firms that tout their employees as experts who have specialized backgrounds tailored to helping you get your tax credits. Whether or not they actually have IRS or legislative backgrounds, at the end of the day, a firm’s work should speak for itself. There is no need for flashy marketing collateral that boasts expertise without proof.

4. They bundle tax work with controversy and audit support

A combo deal is great when it is a burger, fries, and a Coke, but when it comes to your tax work, you should be looking for individualized support. Firms that package tax work with controversy and audit support are trying to catch your eye, saying, “Look at everything we can offer you!” If the tax assessment they provide is strong, these packages are not necessary and you’re paying for something you shouldn’t need in the first place.

5. There is a history (often public) of a toxic work culture

Do not be afraid to Google the firm you are considering. If several articles pop up detailing sordid work environments that include sexual harassment; lawsuits against former clients and employees; and obviously fake Glassdoor reviews, you can assume the firm itself is a red flag.

6. Targeting of less-sophisticated businesses as clients

Be aware of firms that go after mid-market and below businesses that are less “sophisticated” than other potential clients. They will usually peddle less-than-legitimate sales tactics, like promising a Porsche or other luxury vehicle, as an incentive to lure these businesses into hiring them. Red flag firms know less refined companies will not catch on to these “scummy” offers because they do not have the experience to know any better.

7. They employ a “cut-and-paste” approach

Many tax credits, like the R&D tax credit, require year-by-year claims, and in order to qualify, your tax return must depict work calculated and substantiated independent of years past. If a firm utilizes the “cut-and-paste” approach from the year before, this indicates sloppy work — and a red flag indicating you should choose a tax provider willing to perform the work necessary year after year without cutting corners and risking an IRS audit.

Keys to selecting a reliable tax credits and incentives provider

Now that you know what to avoid, here are some things a tax provider should have in order to best assist you with tax credits:

1. They are a full-service accounting firm.

A full-service accounting firm knows how to look at an organization holistically, providing the services necessary simply by peering beneath the hood. They will know how things work, and we are happy to tell you how to optimize — including how tax credits can be used or monetized within your business. Look for a firm that provides tax, audit, controversy, and more services, all under one roof.

2. They prioritize the security of your information.

A good tax provider knows your information is sacred and will treat it as such. While cybersecurity risks are never fully eliminated, stick with a firm with SOC or equivalent data protection. This way you are much less likely to have your sensitive financial information exposed in the event of a data breach.

3. They employ quality control

Look for a firm that utilizes multiple levels of internal review, so you know that the work you are getting has been vetted and approved by a strong system of quality control — all with your best interests in mind. When you are dealing with something like tax credits, you cannot take the easy way out or cut corners, so finding a provider that maintains control strength is crucial.

4. They never make a decision for you

While you want to trust your tax provider, at the end of the day, whatever decisions your organization makes regarding your tax credits affects you and only you. A reliable firm will not pressure you into questionable decisions. They will empower you through thorough education so you can feel confident making the right choice yourself.

5. They charge you a fixed rate based on hours worked

Unlike a red-flag firm, the firm you want to hire only charges a fixed rate based on the hours they work for you, rather than contingency-based charges taken from the recoup. This indicates they are focused on the outcome for you, not what that return means for them. A firm like MGO will perform an initial fact-find to determine eligibility and then make a conservative estimate, so you know exactly what to expect.

6. They follow a professional approach

Professional means qualified, and a good firm provides services from specialists with real certifications and strong backgrounds in the industry. Look for a tax provider that regularly publishes news, articles, and thought leadership detailing emerging opportunities and risks. The team you hire is embarking on a journey with you — and to create opportunities, gain competitive advantages, and see your hard work culminate in rewards, you want to work with someone you can trust: someone proactive and well-informed.

Our perspective on ethics in tax credits and incentives

Tax credits and incentives provide plenty of benefits you do not want to miss out on — and their often-complex application and qualification processes are reason enough to hire a tax provider to help you maximize your returns. However, it is important to be aware that not just any tax provider will do. Be aware of red flags and know what specifically to look for in a firm.

At MGO, our dedicated Tax Credits and Incentives team brings over 30 years of experience. We will take a holistic view of your operations and processes to identify areas where you may be able to claim tax credits and incentives.

About the author

Michael Silvio is a partner at MGO. He has more than 25 years of experience in public accounting and tax and has served a variety of public and private businesses in the manufacturing, distribution, pharmaceutical, and biotechnology sectors.

Here come the child tax credit payments: What you need to know

The first advance payments under the temporarily expanded child tax credit (CTC) will begin to arrive for nearly 39 million households in mid-July 2021 — unless, that is, they opt out. Most eligible families won’t need to do anything to receive the payments, but you need to understand the implications and why advance payments might not make sense for your household even if you qualify for them.

Understanding the CTC, then and now

The CTC was established in 1997. Unlike a deduction, which reduces taxable income, a credit reduces the amount of taxes you owe on a dollar-for-dollar basis. While some credits are limited by the amount of your tax liability, others, like the CTC, are refundable, which means that even taxpayers with no federal tax liability can benefit. Historically, the CTC has been only partially refundable in that the refundable amount was limited to $1,400.

The American Rescue Plan Act (ARPA) significantly expands the credit, albeit only for 2021. Specifically, the ARPA boosts the CTC from $2,000 to $3,000 per child ages six through 17, with credits of $3,600 for each child under age six. Plus, the CTC is now fully refundable. It also affords taxpayers the opportunity to take advantage of half of the benefit in 2021, rather than waiting until tax time in 2022.

Note, however, that there are limits to eligibility. The $2,000 credit is subject to a phaseout when income exceeds $400,000 for joint filers and $200,000 for other filers, and this continues under the ARPA — for the first $2,000. A separate phaseout applies for the increased amount: $75,000 for single filers, $112,500 for heads of household and $150,000 for joint filers.

Receiving advance payments

The ARPA directed the U.S. Treasury Department to begin making monthly payments of half of the credit in July 2021, with the remaining half to be claimed in 2022 on 2021 tax returns. For example, a household that’s eligible for a $3,600 CTC will receive $1,800 ($300 in six monthly payments) in 2021 and would claim the balance of $1,800 on the 2021 return. The payments will be made on the 15th of each month through December 2021, except for August, when they’ll be paid on August 13.

To qualify for advance payments, you (and your spouse, if filing jointly) must have:

  • Filed a 2019 or 2020 tax return that claims the CTC or provided the IRS with information in 2020 to claim a stimulus payment,
  • A main home in the United States for more than half of the year or file a joint return with a spouse who has a U.S. home for more than half of the year,
  • A qualifying child who’s under age 18 at the end of 2021 and who has a valid Social Security number, and
  • Earned less than the applicable income limit.

If the IRS has your bank information, you’ll receive the payments as direct deposits.

Because the IRS will base the payments on your 2020 tax return (or, if not yet available, your 2019 return), it’s possible that you could receive excess payments over the amount you actually qualify for in 2021. In that case — unlike excess stimulus payments — you’ll be required to repay the excess. The IRS will either deduct the amount from your 2021 refund or add it to the amount you owe.

Opting out

The IRS will automatically enroll taxpayers for advance payments, but it’s also providing an online portal at irs.gov where taxpayers can opt out. You might consider opting out if, for example, you were near the income limits in 2019 or 2020, expect to earn more in 2021, and want to avoid excess payments. Be aware that couples filing jointly must both opt out, otherwise the spouse who doesn’t will receive half of the joint payment.

It’s not only a change in expected income that could lead to excess payments; it’s also a change in the number of dependents. For example, divorced couples who share joint custody may alternate the years in which they claim their children as dependents for CTC purposes. If 2021 is your former spouse’s year, consider opting out (your former spouse won’t receive the advance payments based on his or her 2020 tax return but, if eligible, can claim the credit on the 2021 return). Parents of children who will turn age 18 in 2021 also should consider opting out.
The deadline to opt out of the first payment was June 28, 2021, but you can still opt out for future payments.

Estimating, and reducing, 2021 income

When deciding whether to opt out, you can estimate your 2021 income using multiple methods. You could simply look at your modified adjusted gross income on your most recent tax return. You also could project your income for the year and reduce it by the standard deduction (for 2021, it’s $12,550 for individual taxpayers and $25,100 for married couples filing jointly).

If you estimate that your income will be near the eligibility threshold but want to receive the advance payments, you can take measures to reduce your income before year end. You might, for example, increase your 401(k) plan contributions (the contribution limit for 2021 is $19,500). Taxpayers with high deductible health plans and health savings accounts (HSAs) can similarly reduce their income with contributions. The HSA contribution limits for 2021 are $3,600 for individual health plans and $7,200 for family health plans.

Beyond 2021

The expanded CTC is available only for 2021 as of now. President Biden has indicated that he’d like to extend it through at least 2025, and some Democratic lawmakers hope to make it permanent. But it’ll be challenging to pass a bill to make either of these proposals happen. We’ll keep you informed about any developments that could affect your tax planning.

Applying the R&D Tax Credit to Telemedicine Software

During the pandemic, telemedicine services provided important solutions to a system in crisis. They helped ease the burden on health care facilities and staff and offered individuals the care they needed. While in-person visits may have been a preference in the past, COVID-19 demonstrated the convenience and effectiveness of telemedicine for both patients and care providers. Though the health crisis has abated in many areas of the United States, caring for patients remotely through telemedicine will continue to provide important health resources, and valuable opportunities for software developers.

Tax incentives for telemedicine tools

Health care professionals are incorporating tablets, chat capabilities, and other mobile solutions to diagnose more patients in a shorter amount of time and across geographical boundaries. This demand for innovation presents opportunities for software companies, and the development of these technologies is being encouraged by Federal and state Research and Development (R&D) Tax Credits.

About the R&D tax credit

Enacted in 1981, the Federal R&D Tax Credit allows a credit of up to 14 percent of eligible spending for new and improved software products.

To qualify as an R&D activity, one must meet each of the following criteria:

• Technological in nature. Activities must be based on hard science.
• Qualified purpose. Activities must be intended to develop a new or improved product or process.
• Technological uncertainty. Activities must be aimed at eliminating uncertainty with respect to the development of a product or process.
• Process of experimentation. Activities must involve a systemic or iterative approach of evaluating different alternatives to eliminate ambiguity.

Eligible costs include:
• Employee wages
• Supplies
• Contract research expenses

Software companies developing platforms to enable and improve remote health care may be able to take advantage of the R&D Tax Credit as a dollar-for-dollar tax saving for the work that they are already doing.

Software activities that may qualify for a tax credit
If your company is investing in developing telemedicine platforms, you may be able a claim an R&D Tax Credit. Though each situation is unique, development activities for the following products may qualify:

  • Tools that allow physicians to view medical images and other data on mobile devices such as smartphones, tablets, and other electronic devices
  • Application programming interfaces and capabilities to transfer information electronically and view electronic medical files
  • Cloud-based platforms to enable health care providers to directly engage patients in an easy-to-use virtual care environment that is HIPAA compliant
  • Platforms with the capabilities of linking physicians and pharmacies to allow physicians to submit a prescription electronically
  • Wearable devices with sensors to provide continuous monitoring of patients and automated treatment for health conditions
  • Virtual therapy platforms for online counseling
  • Medical data cloud storage solutions and data security

How we can help

The pandemic put our current telemedicine capabilities to the test, and patients gave these innovations a passing grade. But we have yet to experience the true power of telemedicine. As the innovation continues and popularity grows, we can be certain of even more widespread acceptance of telemedicine. And as the need continues to increase, it appears that the various tax credits for research and development will be available to help support the work of those who develop technology in the health care sector.

MGO professionals bring over 25 years of R&D Tax Credit experience to help you identify, analyze, file, and defend your claim. We provide a no-cost eligibility analysis to determine if these tax incentives are appropriate to your situation.

About the author

Michael Silvio is a partner at MGO. He has more than 25 years of experience in public accounting and tax and has served a variety of public and private businesses in the manufacturing, distribution, pharmaceutical, and biotechnology sectors.

Fast Answers on Opportunity Zone Incentives

Tax Alert: Qualified Opportunity Zones

Last year’s Tax Cuts and Jobs Act, H.R. 1 (“the Act”) created a federal capital gains tax deferral program through the opportunity zone statute, which is designed to attract private, long-term investments in low-income and economically distressed communities. Over 8,700 communities designated as Qualified Opportunity Zones (QOZ), located across all 50 states, territories and Washington D.C, were nominated by local governments and confirmed by the Department of Treasury (DoT) in Notice 2018-48 issued in June 2018.

The statutory language of the Act introduced the tax incentive deferring taxable gains but it did not provide important details, including the types of gains eligible for deferral, the timing and specific requirements  of qualified investments, and how investors report deferred gains. On October 19, 2018, the Treasury Department released proposed regulations, a revenue ruling, and tax forms to provide additional guidance on the opportunity zone tax incentive.

How QOZ tax incentives work

Simply stated, the opportunity zone statute allows for the deferral of capital gains if some or all of the amount of the capital gain recognized is invested in a Qualified Opportunity Fund (QOF) by an eligible taxpayer. A QOF is any entity that invests in qualified opportunity zone property and is taxed as a partnership or corporation organized in any of the 50 states, US territories, or D.C. The QOF is required to hold at least 90 percent of its assets in qualified opportunity zone property.

To defer a capital gain, a taxpayer has 180 days from the date of sale or exchange of the appreciated property to invest the recognized gain in a QOF. The potential tax benefits of opportunity zone statute include:

  • Deferral of tax on capital gains invested in a QOF through 2019: Any recognized capital gain invested in a QOF through December 31, 2019 may be deferred until December 31, 2026 or eliminated when an investment in a QOF is disposed. There is an opportunity for taxpayers to make multiple investments in QOFs through the statute expiration date.
  • Potential to eliminate 15% to 100% of taxes for capital gains invested: Capital gains invested in a QOF are deemed to have an initial tax basis of zero. The taxpayer receives a 10% increase in tax basis if the investment is held five years and an additional 5% increase in tax basis after seven years. If an investment in a QOF is held for ten years, the taxpayer can elect to increase their tax basis in the QOF to fair market value upon disposition, which provides for a tax-free investment in the QOF. Tax is realized on the excess of the deferred gain over the basis in the QOF at the time of disposal.
  • Ability to rollover gains on disposal of investments in QOF: In general, the original deferred gain must be recognized by the taxpayer upon disposition of the investment in the QOF. If a taxpayer disposes of all of an investment in a QOF, triggering tax on the deferred gain and the qualified opportunity zone property, a taxpayer can make an investment in a new QOF and rollover the deferred gain. The rollover investment must be made before December 31, 2026.

Qualified Opportunity Zone Property

The purpose of the opportunity zone statute is to incentivize investment in low-income areas of the country in need of community development and improvement. IRC Sec. 1400Z-2(d)(2) provides guidance regarding the types of assets that will be considered qualified opportunity zone property if held by a QOF. In general, qualified opportunity zone property includes the following:

  • Newly issued stock held in a domestic corporation if such corporation is a qualified opportunity zone business,
  • Newly issued partnership interests in a domestic partnership if such partnership is a qualified opportunity zone business, or
  • Qualified opportunity zone business property.

Qualified opportunity zone business property is further defined in IRC Sec. 1400Z-2(d)(2)(D) as tangible property used in a business in a qualified opportunity zone that is either:

  • Land in a qualified opportunity zone,
  • A building in a qualified opportunity zone that is first used by the QOF or the qualified opportunity business,
  • A building in a qualified opportunity zone that was previously used but is “substantially improved” by the QOF or qualified opportunity business,
  • Equipment that was never previously used in a qualified opportunity zone, or
  • Equipment that was previously used in a qualified opportunity zone but it “substantially improved” by the QOF or the qualified opportunity business.

The opportunity zone statute defines “substantial improvement,” as an amount of investment in existing tangible property by a QOF, during any 30-month period, that exceeds the adjusted basis in the property at the beginning of the 30-month period. The Revenue Ruling issued clarifies that improvements made to land are not included in the total improvements for purposes of the “substantial improvement test” and the value of land is excluded from the adjusted basis calculations.

More details on qualifying as a QOF

The new guidance also provides details on what qualifies an investment vehicle as a QOF. And a draft of Form 8996, Qualified Opportunity Fund was released alongside the guidance to demonstrate how corporations and partnerships can self-identify as a QOF by including the form with the filing of their tax return. Additional information provided includes guidelines for determining when a QOF begins, how a QOF can meet the requirements to be recognized as a qualified opportunity zone business, and what pre-existing entities may qualify as a QOF. And finally, guidance details the test required of QOFs to determine whether the entity holds the minimum threshold of assets in qualified opportunity zone property.

Considering a QOZ investment?

While the new guidance helps fill in many details, many questions are left unanswered and the Department of Treasury plans to release further guidance before the end of the year. If you’re planning on creating or investing in a QOF, we recommend consulting with an experienced tax advisor first.

The tax team at MGO is ready to assist you in navigating QOZs, QOFs, and other income tax concerns. For further guidance or to schedule a consultation, please contact us.