How Manufacturers Can Take Advantage of Tax Credits and Incentives

GALLINA LLP  Largest accounting firm in the Sacramento region  Top 10, largest accounting firms in California / “Top 100 Firm” nationally  Several teams of specific industry specialists  2014 Corporate Citizen of the Year recipient from the Boy Scouts of America, Golden Empire Council

Today’s Topics  Research & Development Tax Credit  California New Employment Credit (“NEC”)  Work Opportunity Tax Credit (“WOTC”)  Sales Tax Exemption for Manufacturing or R&D

Research & Experimentation Tax Credit Credit for Increasing Research Activities

What is the Benefit?  Manufacturing client that designs and manufactures compressors for various applications.  Just of $1.5 million of qualifying R&D expenses. – $1,100,000 spent on salaries & wages (28 people internally spending an average of 39% of their time performing qualifying R&D activities). – $450,000 spent on prototype materials and testing various sealant materials. – $32,000 paid to 3 rd parties to perform qualifying research on behalf of our client.  Resulted in a tax credit of $176,000.

The Benefit  Manufacturer’s taxable wages, supply costs, and contractor costs are “deductions” which are all fully deductible on the tax return.  A tax “credit” is an additional benefit that is a dollar for dollar offset against the amount of taxes you owe.

What is a “Qualifying” Activity? Qualifying Activities – Engineering Efforts – New Product Design – Substantial Improvements – Computer Modeling – Experimentation Efforts – Laboratory Testing – Developing Prototypes – Technical Discussions – Unsuccessful but Otherwise Qualifying Initiatives Non-Qualifying – Reverse Engineering – Market Research – Research Related to Style or Consumer Taste – Research Related to Management Techniques – Adaptation (simple) of an Existing Product or Process – Research Conducted Outside the U.S.

From Concept to Production Concept Development Applied Research DesignPrototype First Run & Testing Customer Deliverable Subsequent Revisions

Statutory Qualifying Criteria Permitted Purpose The activity must relate to a new or substantially improved product or process intended to improve: - Function - Performance - Reliability - Quality Technological in Nature The activity must fundamentally rely upon principles of: - Engineering - Physical Science - Computer Science - Biological Science Technological Uncertainty The activity must be intended to discover information to eliminate technological uncertainty related to: - Appropriateness of a product design - Method of a product or process - Capability of a product or process Process of Experimentation Substantially all (80%+) of the activities must relate to a systematic process of experimentation involving: - Evaluation of one or more alternatives - Confirming hypothesis through trial/error, testing and/or modeling/simulation Four-Part Test

From Concept to Production Concept Development Applied Research DesignPrototype First Run & Testing Customer Deliverable Subsequent Revisions

Research Pursuant to Contract Substantial Rights – Must retain rights to I.P. and be able to use what is learned on subsequent projects. – Rights do not have to be exclusive Risk – Fixed-price fee arrangement – Payment contingent on success of the research – Warranty provisions – Cannot be T&M, Cost +, or GMP unless there is a compelling case to be made

What Expenses Can Be Included?  Salaries and Wages – Typically largest component (roughly 90%+)  Supply Costs – Cannot include capitalized assets (equipment)  Contractor Costs – 65% of qualifying costs are eligible

R&E Credit Study Process  Identify Qualifying Business Components  Identify Personnel Who Were Involved  Identify Hours By Employee By Activity For Each Qualifying Business Component  Identify Supplies Consumed While Performing Qualifying Activities  Identify Contractor Costs Related to the Performance of Qualifying Activities on Qualified Projects (Business Components)  Calculate the Tax Credit Amount

Any Questions? ?

California New Employment Credit California Hiring Incentive

Enterprise Zone Credits  The “Enterprise Zone” hiring credit has expired as of December 31,  Unused credits may carry forward for up to 10 years.  Qualifying new hires under the old program who were previously vouchered, will continue to generate credits for up to 5 years from their original hire date.

New Employment Credit (NEC)  The NEC credit applies to hiring beginning January 1, 2014 and is worth up to $56,000 per qualifying new hire, over 60 months (5 yrs)  Not available for retailers, food service, temporary employment agencies, casinos, bars, or sexually oriented businesses  Allows businesses to claim NECs in certain economic development areas (former EZs and LAMBRAs, with some exceptions), as well as in designated census tracts with high unemployment and poverty rates  Available for hiring employees who are long-term unemployed; unemployed veterans; ex-felons; or recipients of the federal earned income tax credit, CalWORKS, or general assistance  Only available to employers that create net new jobs statewide

New Employment Credit (NEC)  Tentative Credit Reservation (TCR) for each qualified employee must be made within 30 days of hire date  Hiring Credit may be taken only on an originally filed income tax return (no amended returns)  Computation of an “applicable percentage” – The net increase in full-time employees in CA is the numerator of the fraction while the denominator is the number of “qualified” full-time employees in the state

Example 1 Situation (NEC)  Taxpayer A operates entirely within California and has a location within the DGA. As of December 31, 2013, Taxpayer A has a total workforce of 250 employees which consists of 150 part time and 100 full-time employees. During its taxable year 2014, Taxpayer A hired new full-time employees, 2 of which were qualified full-time employees. Taxpayer A received a tentative credit reservation for these employees as required. Assume the following facts:  Qualified Employee 1 was hired on January 1, 2014, at an hourly wage of $17 and worked 2,000 hours during taxable year Qualified wages for Employee 1 are $5 per hour ($ $13.50). Qualified Employee 2 was hired on July 1, 2014, at an hourly wage of $18 and worked 1,000 hours during taxable year Qualified wages for Employee 2 are $6 per hour ($ $13.50). The Base Year is taxable year In its base year, annual full-time equivalent employees were 100. Full-time equivalent employees in 2014 were 108. The net increase in annual full-time equivalent employees over the base year is 8.

Example 1 Calculation Tentative Credit Amount:$5,600 Qualified Employee 1:$3,500 ($5 x 2000 hours x 35%) plus Qualified Employee 2:$2,100 ($6 x 1000 hours x 35%) Applicable Percentage:100% Numerator: = 8 (Net Increase in full-time employees) Denominator:2 qualified full-time employees Computation:8/2 = 100% (the applicable percentage cannot exceed 100%) Credit Allowable:$5,600 ($5,600 x 100%)

Example 2 Situation  The qualified taxpayer has a net increase in full-time employee equivalents – receives a partial amount of the tentative credit.  Assume the same facts as Example 1, except due to attrition the annual full-time equivalents for taxable year 2014 was 101. The net increase in annual full-time equivalent employees over the base year is 1 ( ).

Example 2 Calculation Tentative Credit Amount:$5,600 Qualified Employee 1:$3,500 ($5 x 2000 hours x 35%) plus Qualified Employee 2:$2,100 ($6 x 1000 hours x 35%) Applicable Percentage:50% Numerator: = 1 (Net Increase in full-time employees) Denominator:2 qualified full-time employees Computation:1/2 = 50% Credit Allowable:$2,800 ($5,600 x 50%)

Example 3 Situation  The qualified taxpayer does not have a net increase in full-time employee equivalents – receives no amount of the tentative credit.  Assume the same facts as Example 1, except due to attrition the annual full-time equivalent for taxable year 2014 was 98. The net increase in annual full-time equivalent employees over the base year is zero ( but it cannot be less than 0).

Example 3 Calculation Tentative Credit Amount:$5,600 Qualified Employee 1:$3,500 ($5 x 2000 hours x 35%) plus Qualified Employee 2:$2,100 ($6 x 1000 hours x 35%) Applicable Percentage:0% Numerator: = 0. (Net Increase in full-time employees cannot be less than zero) Denominator:2 qualified full-time employees Computation:0/2 = 0% Credit Allowable:$0 ($5,600 x 0%)

Work Opportunity Tax Credit (“WOTC”) Federal Hiring Incentive

WOTC  Currently expired as of December 31, 2013 but expected to be retroactively extended through 2015 with the EXPIRE Act.  Worth up to $9,600 per qualifying new hire.

WOTC Qualifying New Hire  Credit for hiring qualifying persons. A qualifying person is: 1.A member of a family that is a Qualified Food Stamp Recipient 2.A member of a family that is a Qualified Aid to Families with Dependent Children (AFDC) Recipient 3.Qualified Veteran 4.Qualified Ex-Felon, Pardoned, Paroled, or Work Release Individual 5.Vocational Rehabilitation Referrals 6.Qualified Summer Youth 7.Qualified Supplemental Security Income (SSI) Recipient 8.Qualified Individuals living with an Empowerment Zone or Rural Renewal Community 9.Long Term Assistance Recipient (TANF) – formerly known as Welfare to Work

Claiming the WOTC  Complete Form 8850 by the day the offer is made.  Complete ETA Form 9061 or ETA Form 9062  Submit the completed and signed IRS and ETA forms to your state workforce agency (California EDD) within 28 calendar days of the employee’s start date.

Manufacturing and Research & Development Equipment Exemption Sales Tax Exemption

Planned Purchases? Does anyone here plan on making purchases of manufacturing or R&D equipment?

Real World Example  Client plans purchase of $17 million of manufacturing plant equipment  GALLINA received a private opinion from the State that these purchases would qualify  Client will save in excess of $700,000

Manufacturers Sales Tax Exemption  Beginning July 1, allows manufacturers to obtain partial exemption (currently %) of state sales and use tax on certain manufacturing and research and development equipment purchases.  To be eligible under AB 93, a Taxpayer must meet all three of the following conditions: 1.Be engaged in certain types of business, also known as “qualified person”, 2.Purchase “qualified property”, and 3.Use that qualified property for the uses allowed by this law  “Qualified Person” = Someone primarily engaged (50% or more of the time) in those lines of business described in the North American Industry Classification System (NAICS) Codes 3111 to 3399, inclusive, , or – These industries generally include those primarily engaged in the business of all forms of manufacturing, research and development in biotechnology, and research and development in the physical, engineering, and life sciences.

Manufacturers Sales Tax Exemption  “Qualified Property” includes the following used in manufacturing processes or R&D activities: – Machinery and equipment, including component parts and contrivances such as belts, shafts, moving parts, and operating structures – Equipment or devices used or required to operate, control, regulate, or maintain the machinery (computers, software, repair/replacement parts) – Tangible personal property used in pollution control that meets established state or local government agency standards – Special purpose buildings and foundations used as an integral part of the manufacturing process, or that constitute a research or storage facility. Buildings used solely for warehousing do not qualify. Does not include consumables with a useful life of less than one year, furniture, inventory, equipment used in extraction processes, equipment used to store finished products that have completed the manufacturing, processing, refining, fabricating, or recycling process, or tangible personal property used primarily in administration, general management, or marketing.  This new program applies the exemption to qualifying purchasers throughout California, without regard to geographic boundaries.  Requires the issuance of an “exemption certificate” at the point of sale.

Any Questions? ?

GALLINA LLP Contact Information Mark Bellows, CPA Partner – Manufacturing Practice Leader Jesse Wutkee, CPA Senior Manager – Tax Credits & Incentives Practice Leader Shevar Goonwardena, CPA Senior Manager – Manufacturing Audit and Assurance