Look for tax credits and incentives
Opportunities for the government contractor when engaging with customers
INSIGHT ARTICLE |
As a company doing business with state and federal governments, you’re subject to a number of operating variables. These variables range from strict compliance with federal acquisition regulations and government cost accounting standards to federal and state tax liabilities and, sometimes, even tax opportunities. Knowing which issues apply to you is critical to your ongoing productive relationships with your customers and your contracting officers and to your overall success. To that end, tax credits and incentives require a particular amount of insight on your company’s part. Uncovering these helpful credits can provide additional financial benefits that can enable you to take on new contracts or task orders, as well as open doors with other agencies. The following overview provides some key items to keep in mind related to state and federal tax credits and incentives available to government contractors.
State credits and incentives can be prompted by a variety of activities, including contracting activity that can lead to grants and loans, withholding rebates and credits, property tax reductions, utility rate reductions, workforce training reimbursements and more. It’s important to understand the terms and conditions of your contracts thoroughly to determine if incentive opportunities could apply. Before bidding on a contract and when interfacing with state governments in the jurisdictions where contact performance will occur, keep the following business triggers in mind:
- Job creation or retention
- Capital investment (e.g. facilities and equipment)
- Expansions and relocations
- Renewal of long-term leases
- Research and development
- Specific business locations
- New and existing employee training
- Efforts to increase the use of energy from renewable sources
For example, there are various programs sponsored by state and federal government agencies that may offer tax credits and incentives opportunities for your company. These programs include:
- Work Opportunity Tax Credit (WOTC). The WOTC program incentivizes employers who hire targeted groups of individuals, including, but not limited to, qualified veterans, designated community residents, qualified supplemental nutrition assistance program (SNAP) benefits recipients and several other groups. This credit can be claimed against the regular federal income tax or the federal alternative minimum tax. In addition, several states offer credits that mirror the federal credit for hiring WOTC-eligible employees in their states.
- Enterprise or other specified zone credits. Businesses located in designated areas may qualify for enhanced tax credits. In many cases, benefits include sales tax exemptions or credits, income tax credits, property tax incentives and other benefits.
- Training incentives. Many states offer training grants or other credits against income or withholding taxes for expenses incurred to train new or existing employees. Some states allow on-the-job training to be included for purposes of incentives and grants. These incentives are generally available even if the wages are recoverable under a federal contract.
- State “piggy-back” credits. In addition to offering a state-level WOTC credit, many states have credits that mirror the federal research and development (R&D), historic rehabilitation and renewable energy credits. These programs allow taxpayers to receive benefits at the federal and state levels and are not mutually exclusive.
Other important credits and incentives triggers are the specific state or region in which your company operates and where the contract services are performed. For instance, some states located in the Eastern United States (Alabama, Florida and others) have credits and incentives programs that specifically target aerospace and defense contractors, along with other types of businesses. Other states (Virginia and Maryland, for instance) have programs that target company headquarters, as well as the biotech and service industries. Understanding the opportunities in these various states can help you secure both above-the-line and below-the-line benefits you might otherwise miss.
When working with federal government agencies, the following tax credits should be considered:
Research and development tax credit (section 41)
Potential government recipients of R&D services and the government contractors performing these services may be able to take advantage of this credit, if applicable. In practice, the government agencies that typically engage in these services include:
- U.S. Department of Defense
- U.S. Department of Homeland Security
- U.S. Department of Transportation
- State and local infrastructure agencies
- State and local law enforcement agencies
- State and local fire protection agencies
To qualify for the federal R&D credit, a government contractor must first overcome the funded research exception, which means the contractor must bear financial risk (e.g., through either a success-based fee or fixed-fee contract) and retain substantial rights to the research results.
In addition, the R&D activities must meet a four-part test to be considered qualified research. This test requires:
- Technical uncertainty at the project’s outset regarding capability, method or appropriate design
- An intent to discover information that is technological in nature by relying on biological or physical science, engineering or computer science
- An attempt to resolve uncertainty through a process of experimentation
- A permitted purpose, which includes the new or improved function, performance, reliability or quality of a business component
Examples of qualified projects include:
- Development of weapons systems
- Development of armored vehicles
- Development of naval vessels
- Development of military aircraft
- Development of surveillance equipment
- Development of cybersecurity applications
- Development of communication systems
- Development of transportation systems
- Certain aspects of engineering design of roads, bridges, rail lines and other infrastructure projects
- Certain aspects of building architecture and engineering
Other federal tax credit programs warranting consideration include:
- Domestic production activities deduction (section 199)
- Historic building rehabilitation credit (section 47)
- Energy efficient commercial building deduction (section 179D)
- Energy investment tax credit (section 48)
These state and federal tax credits and incentives opportunities for government contractors may be available for your business. To assess your opportunity, consult with a tax advisor that is experienced with helping government contractors benefit from these programs.