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Apply These Breaks

Small and midsize companies shouldn't overlook these tax incentives for research and development, exports, and energy efficiency.
Marielle Segarra, CFO Magazine
April 15, 2012

Tax regulations can be complicated, confusing, and downright off-putting — even those that are intended to deliver a benefit to qualifying companies. Indeed, the sheer complexity of tax incentives often leads small companies with limited resources to avoid them altogether, says Karen Kurek, national leader for manufacturing and distribution at McGladrey & Pullen LLP, which provides assurance, tax, and consulting services.

"I think that few small [to] midsize manufacturers really take advantage of these [incentives], because they perceive that they are too complex and too costly, or they think they don't have the internal resources to devote attention to them," she says.

But some tax incentives may amply reward the effort needed to decipher them. Here are three such opportunities that experts say small companies should consider, complexity notwithstanding:

1. The research-and-experimentation tax credit. The R&E tax credit reduced companies' cost of doing new qualified research by an estimated 6.4% to 7.3% in 2005 (the last year for which data is available), according to a 2009 Government Accountability Office report.

But many small companies don't take advantage of the credit, because they don't consider what they do to be research and experimentation, says Dean Zerbe, national managing director at Alliantgroup and former tax counsel to the U.S. Senate Committee on Finance. "Small and [midsize] businesses often think they need to have a lab full of scientists wearing white coats to qualify," Zerbe says. In reality, improving a product or a process that already exists can also count as research and experimentation, he says.

One company that Kurek worked with undertook a process-improvement initiative on its factory floor and took an R&E tax credit for many of the costs of redesigning its production flow, she says. Companies that improve or extend the life of a product can also qualify for the credit, adds Kurek.

For instance, consider a company that manufactures automobile engines and produces a valve that is compatible with only one type of engine. If that company redesigns the valve to make it compatible with other engines, that redesign could qualify for R&E tax consideration, Kurek says.

As has happened many times since its initial passage in 1981 as a temporary provision, the R&E credit expired again, at the end of 2011. But if recent history is any indication, the credit will be extended for 2012. Meanwhile, President Obama recently proposed making it permanent.

2. The interest charge–domestic international sales corporation. Another frequently overlooked incentive, the IC-DISC can save small and midsize companies as much as 20% on income from exports. The provision enables companies that sell products or services abroad to reduce their tax bills by creating separate tax entities that are taxed at the capital-gains rate of 15% rather than the ordinary-income rate, which can be as much as 35%.

Here's how it works. A company pays a tax-deductible commission based on its export income to the separate entity, the IC-DISC. The IC-DISC then pays dividends to the exporter that are taxed at a capital-gains rate. Parts manufacturers that ship products overseas can take the credit. So can architectural and engineering firms, if they design buildings in the United States that are then built in other countries.

The downside: the provision that allows companies to pay tax on these IC-DISC dividends at the capital-gains rate will expire at the end of this year, unless it is extended. Companies must therefore carefully consider whether it is worth the cost of setting up an IC-DISC right now.

3. The energy-efficient commercial-building deduction. Small businesses can take this deduction if they build or retrofit their offices, warehouses, factories, or other commercial buildings to be energy efficient. Such buildings must have 50% lower energy and power costs than buildings that adhere to 2001 federal energy standards for lighting, heating, cooling, ventilation, and hot water. Architectural or engineering firms can also tap into this benefit if they design energy-efficient buildings for the government, such as dorm rooms for public universities.

It isn't hard to qualify for this deduction. That's because many companies must already comply with state energy-efficiency laws that are stricter than the federal standards, Zerbe says. Businesses can also partially qualify: if they don't hit the target percentage, they can still receive a tax credit that comes out to "a very significant savings," he says.

In addition, companies that take this credit may save on energy costs in the long run. But there's a cost to qualifying, since companies must hire an independent engineer to evaluate the buildings. The deduction may thus not offer much return on investment for buildings smaller than 50,000 square feet, cautions Zerbe.

The credit will expire at the end of 2013.




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