Three Overlooked Small-Business Tax Breaks

Small and midsized companies may be missing opportunities in research and development, exports, and energy efficiency.
Marielle SegarraFebruary 24, 2012

The language of tax rules is often considered dense, confusing, or downright off-putting. Indeed, the complexity of understanding and qualifying for tax incentives often leads small companies with limited resources to avoid them altogether, says Karen Kurek, national leader for manufacturing and distribution at McGladrey.

“I think that few mid-small 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,” Kurek says. But small businesses that count themselves out could be leaving much-needed money on the table, she says.

Here are three tax incentives that experts say small companies often overlook, and should consider.

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1. The Research and Experimentation (R&E) Tax Credit

The R&E credit reduced companies’ cost of doing new qualified research by an estimated 6.4% to 7.3% in 2005 (the last year available), according to a 2009 Government Accountability Office (GAO) 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 medium businesses often think they need to have a laboratory 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 development, he says.

One example: a company that Kurek worked with implemented 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, she adds.

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 that valve to make it compatible with other engines, that redesign could qualify for R&E tax consideration, Kurek says. As it has many times in the past, the R&E credit expired this year. If the credit follows past form, it will temporarily be renewed. This year, however, President Obama has proposed making it permanent.

2. The Interest-Charge Domestic International Sales Corporation (IC-DISC)

Another often overlooked incentive, the IC-DISC can save small and mid-sized companies as much as 20% on income from exports. The provision enables companies that manufacture and ship products or services abroad to reduce their tax bill by creating separate tax entities called IC-DISCs that are taxed at the capital gains rate, a lower rate than income taxes.

Here’s how it works. A company pays a tax-deductible commission based on its export income to this separate entity, its IC-DISC. The IC-DISC then pays dividends to the exporter that may be taxed at a capital gains rate of 15%, a lower rate than the ordinary income tax rate, which could be as much as 35%.

Parts manufacturers can also qualify for this, for example.  Thus, a company that builds tires for cars that are shipped overseas could take the credit, says Zerbe. And architectural and engineering firms can take the credit 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 consider carefully 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, which expires at the end of 2013, if they build or retrofit their offices, warehouses, or 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.

Qualifying for this deduction isn’t very difficult. 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, he cautions.