When you set out to build a successful company, it’s vital to effectively utilize every tool available to increase your odds of success. And if you choose Connecticut to establish or expand your business, the good news is that there are several significant tax incentive programs as well as valuable experts to guide you on their implementation.
One such expert is Fiondella, Milone & LaSaracina, an accounting and tax firm with a long track record of assisting companies with all aspects of corporate formation, accounting, reporting and tax compliance. They are particularly adept at helping companies take maximum advantage of the many Connecticut and federal tax credits available. For some of the specifics, we reached out to Bill Claffey and Lisa LaSaracina, both Partners in Tax Services at FML, and Justin Wilcox Sr. Manager in Tax Services at FML. The following article offers a high-level overview of tax opportunities worth pursuing.
Research & Development Tax Credits
Research and development is the key to most groundbreaking innovations. But for entrepreneurs and their young companies, the costs can be daunting. Here, FML describes the specific tax credits that can help defray some of those R&D expenses.
- Connecticut Incremental R&D Credit—This is a 20 percent tax credit for “incremental” R&D spending, or the year-over-year increase in R&D spending. For example, if your company spends $300k in 2017 and $400k in 2018, then a $100k increase times a 20 percent credit would be $20k. You can take the credit in one of two ways.
- Option 1: If your company does not yet have taxable income, as many startups don’t, the credit can be turned into immediate cash at 65 cents per dollar ($20k credit = $13k cash refund).
- Option 2: Eliminate 65 percent of State of Connecticut corporate tax (70 percent starting in 2019) and carry the remainder forward ($20k in corporate taxes due in 2018 = $13k credit allowed in 2018 with $7k remaining for 2019).
- Connecticut Non-Incremental R&D Credit—This is a 6 percent tax credit for overall R&D spending in addition to the 20 percent incremental credit. Continuing from the prior example, with $400k in total 2018 R&D spending, $100k is eligible for the incremental credit and $300k is eligible for the non-incremental credit ($300k × 6 percent = $18k credit). How you take the credit depends on whether your company has taxable income.
- Option 1: No taxable income—cash refund of 1/3 of credit at 65 cents on the dollar and carry forward 2/3 against future corporate tax ($18k credit = $6k at 65 cents/dollar for $3.9k cash refund and $12k carry forward).
- Option 2: Taxable income—eliminate 65 percent* of State of Connecticut corporate tax per year (70 percent starting in 2019) and carry the remainder forward.
* Only 1/3 of the credit can be used in year 1 (subject to other limitations), so $18k credit in 2018 = $6k to offset 2018 CT corporate taxes.
- U.S. Federal R&D Credit—This is a 20 percent “regular” tax credit for R&D spending, or 14 percent** using the “alternative” calculation, to offset U.S. corporate income tax (carried forward if the company owes no U.S. tax). In addition, as of 2016, up to $250k of federal R&D tax credits may be used to reduce U.S. payroll taxes—a very beneficial provision for startups in a loss position (certain taxpayer qualifications apply, and a specific tax return election is required).
** The 14 percent credit is easier to substantiate than the 20 percent credit and hence is more likely to be utilized. It’s a complex issue related to the base-period calculation that is beyond the scope of this article and best discussed with an accounting professional.
What Qualifies as an R&D Expense?
One of the details to pay attention to is how an R&D expense is defined for the purposes of these tax credits. Of particular benefit to startups in Connecticut is the state’s much broader base of what qualifies as an R&D expense versus the U.S. tax code. For instance, while the U.S. federal R&D credit applies solely to wages, supplies and consulting fees, the Connecticut credit also covers other expenses directly related to R&D, including rental space for R&D labs, utilities directly utilized to power R&D equipment, and legal fees for patent research, filings and such.
It’s crucial to note that to qualify for the Connecticut R&D tax credits, the expenses must occur and the services must be provided within the state of Connecticut. In addition, your company must be taxed as a C corporation to receive Connecticut R&D credits.
Capital Investment Corporate Tax Credits
To encourage investments in property, jobs and people in the state, Connecticut offers several tax incentives to offset corporate income tax—a great way to fund capital expenditures.
- Connecticut Fixed Capital Investment Credit—This 5 percent tax credit is for qualified fixed asset purchases. The asset must be purchased from an unrelated party and have a class life of at least four years. The asset also must be held in Connecticut for at least five years—not transferred to a related party, purchased and then leased within 12 months, or sold out of state—or the credit will be subject to recapture.
- Connecticut Incremental Equipment and Machinery Expenditure Credit—For companies with less than 250 employees, this 10 percent tax credit is given for a year-over-year increase in purchases of manufacturing equipment and machinery to be used in Connecticut—this includes repair parts as well as software to operate the equipment.
- Connecticut Human Capital Investment Credit—This 5 percent tax credit is applied for expenses related to Connecticut employee training and education, which can include training materials, registration fees, tuition, instructor fees, travel to training events within Connecticut, and even donations to institutions of higher education. What’s more, the credit can also be used to cover the cost of building a daycare center within the company facility.
Digital Media Tax Credits
To attract industry expansion in Connecticut, the General Assembly established tax credits for the production of digital media and motion pictures. To obtain credits, you must apply to the Connecticut Department of Economic and Community Development. If approved, you may receive credits to offset State of Connecticut corporate tax. In addition, unlike the other credits covered in this article, digital media credits may be sold, assigned or otherwise transferred to another taxpayer.
- Film Production Credit—This tax credit of up to 30 percent is for qualified digital media and motion picture production, pre-production and post-production expenses incurred in the state. A broad array of business ventures beyond television programs and motion pictures qualify for the credits, such as music videos, commercials, trailers, video games, interactive websites and more.
- Digital Animation Credit—This tax credit of up to 30 percent is for expenses related to the creation, development and production of computer-generated animation content for distribution or exhibition to the general public.
- Film Production Infrastructure Credit—This tax credit of up to 20 percent, not to exceed $3 million, is for expenditures on capital projects to provide buildings, facilities or installations for film, video, television, digital media or digital animation production.
Enterprise Zones provide benefits such as property tax exemptions and corporate tax credits to companies that establish a presence in specified economic zones within the state of Connecticut. Eligibility depends on approval by the Department of Economic and Community Development.
Foreign Companies Establishing a U.S. Presence
There are myriad issues for foreign companies seeking to establish a U.S. presence. From decisions about legal entity formation to a host of accounting, tax, recordkeeping, personnel and other logistical details, expert advice can be invaluable as missteps can be costly and disruptive to your business. The following is a partial list of crucial matters to address as you consider a U.S. expansion of your foreign company.
- Establishing a U.S. legal entity. If you will establish a U.S. domicile subsidiary of the parent company, it’s important to consider the tax classification and other issues related to choosing a C corporation versus an LLC, limited partnership or other entity type.
- Creating separate accounting to segregate U.S. transactions and payroll from the parent entity.
- Conforming accounting to U.S. GAAP versus IFRS or other applicable foreign accounting rules and standards.
- Determining transfer pricing for intercompany transactions and decisions about overhead allocation between the U.S. and foreign entity.
- Determining how to fund the U.S. operation with debt and/or equity and how to manage cash flow between entities.
- Filing U.S. tax returns including international disclosures and other required reporting. Sales, payroll, property and income tax returns must be filed. 1099 forms for U.S. subcontractors must be issued, and Form 5472 must be completed to disclose significant foreign shareholders.
- Understanding the implications of cross-border transactions between the U.S. entity and foreign parent company with special attention to any applicable treaties.
- Fully utilizing U.S. entity tax credits and incentives to reduce U.S. income and payroll taxes.
- Complying with U.S. bank account reporting requirements related to the U.S. company’s ownership/signatory in foreign bank accounts (including requirements for U.S. officers with signatory rights on foreign parent accounts).
- Addressing issues related to foreign personnel working in the United States. If expatriates will spend time working in the United States, whether temporarily or permanently, there are issues related to the income they earn while in the United States as well as issues such as obtaining green cards or work visas.
While this article has offered an overview of some very beneficial tax incentives for businesses operating in Connecticut, these programs are only as useful as your ability to comply with the rules of implementation. Rather than attempting to navigate the intricacies on your own, you will be well served to seek professional guidance from a firm like FML that knows all the ins and outs of current tax credits and incentives and is always on the alert to take advantage of tax law changes and new opportunities as they occur.
About Fiondella, Milone & LaSaracina LLP
FML is a public accounting firm with 60-plus employees headquartered in Glastonbury, Connecticut. Their practice is dedicated to providing individualized audit, tax and business consulting services to a wide array of companies including early-stage, high-growth, traditional middle-market companies as well as those operating in publicly traded markets.