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Maximizing Employer Tax Credit and Incentive Claims Through Better Compliance

June 6, 2023 by John Skowronski

When the excitement of the site selection process is over and building out the project has occurred, the time to monetize any economic development incentives that were granted eventually arrives. For too many companies they find out the hard way that they probably should have planned a little better and perhaps negotiated the deal a little differently to streamline the compliance process and maximize their employer tax credit opportunities.

Even companies that have done the incentives dance countless times still fail to accomplish these ends; whether it’s an unfamiliarity with the nuances of a particular program’s requirements, or simply an unfamiliarity with the data that needs to be provided on reports. In either case, millions of dollars can go unclaimed, and, in some cases, a complete default can occur.

Understanding the nuances of a program isn’t easy but hopefully a few pointers may help.

Rules and Requirements for Tax Credit and Incentive Programs

When dealing with a tax credit program, the tax code, the regulations, any departmental rulings as well as any experience under audit all come into play and can dramatically impact how a company goes about completing compliance reports.

When dealing with a discretionary program, an agreement generally governs. However, knowing how the program is audited and the standards of proof often required can also impact how a company files reports and how much of an award is received.

Too many times companies abandon incentives or are told later, when it’s too late, that their way of doing things won’t qualify for the program. Take for example training grants. Training grant money is often thrown around during an incentive negotiation as a deal closer and the amount of money can seem significant. However, when the company goes to tap into those funds, they sadly find out that the way they train employees, where they train them or even who trains them is governed by the rules of the training grant program and not conducive with the company’s way of doing things. Many companies aren’t willing to modify their way of doing things or share trade secrets while doing so and choose to leave the money on the table all together.

Take a cash grant program like the Texas Enterprise Fund. The program does not allow intra-state transfers to qualify as eligible employees. With projects oftentimes taking years to construct, many companies lease temporary space to house employees slated for the project site. Well, unless you have negotiated the use of a temporary site as part of your agreement, those employees who start at a temporary site and end up at the project site are tainted and can’t qualify as an eligible employee.

Oops!

For some companies, this could cause them to be completely ineligible for the incentive. How would a company know to include a temporary site in their agreement? Good question! It’s not volunteered by them but if you know its going to happen, talk about it with them in advance. They can accommodate you.

The moral of the story is to seek out as much information as possible. Talk to companies that have been through the process. Use advisors that have worked the programs before. Be sure to have a conversation with people from the agency that administers the program, not just your friend state or local economic developer. Ask the people from the agency hard questions! “How many companies get their full award? Why do companies fail to get their full award?” Don’t be shy! Kick the tires…hard. The car may be pretty, but will it run?

There is another area that companies unfortunately fall flat on and that is calculating incentives, employer tax credit or not, that involve payroll data. This part may be boring, but trust me, it’s important!

Accurately Calculating Your Credit and Incentive

Many programs require that eligible employees work a certain number of hours on average and earn a certain wage on average. If anyone has ever looked at raw payroll data, it can be overwhelming. Trying to slice and dice the data to get to the correct numbers needed to run a calculation requires a deep knowledge of payroll, payroll taxation and the nuances of the payroll system that is used to run the payroll. Something like overtime pay can be a nightmare depending upon how it’s tracked in the payroll system, yet overtime can be the golden goose when it comes to maximizing incentives.

Something as simple as knowing the wage base used to calculate an incentive is the first step. Is it gross wages, FUTA Wages, FICA Wages, or something else? How is the data tested by an auditor? You can be sure a thorough auditor will ask for a year end pay stub for a sampling of employees to see what’s what. Ideally whoever is calculating the employer tax credit would do the same.

One/Zero Analysis

Many employer tax credits across the county use a method of determining monthly average headcount by what is commonly called the “One/Zero Analysis”. The calculation basically takes the eligible employees and determines what months an employee worked. Some states use the 15th of the month, others use the last day of the month. Some states allow part-time employees to aggregate to full-time employees whereas others do not. If the requirement is 35 hours per week, 34.99 hours don’t get you there and if the wage rate is $500 a week, $499 a week may as well be $1 per week.

For the One/Zero Analysis, getting the employee over the required hour and wage requirements can be difficult when working with large numbers of employees, especially when there is high turnover and sporadic work schedules. The states understand that companies create “positions” and that any one position can be filled by any number of employees during the year. For that reason, any one employee may be counted for a few months during the year and one or more other employees would fill out the balance of the year for the position in question. Each employee must first qualify with the requisite average hours and wages and then gets counted in the months that they worked on the measurement date. Seems simple enough right?

Not quite!

Most companies run their calculations using data points from the payroll without looking at the detail. For example, a company that allows employees to work for a period, then not work for a period, and then come back to work later on, that company may very well be miscalculating an employee’s eligibility. Post-COVID in the crazy work-a-day world that has evolved, this kind of work schedule has become even more popular.

Eligible Weeks Worked

Assume, as an example, that an employee was hired in 2021 and is still there in 2023 and the employer tax credit is being claimed for 2022. They worked all of 2022, right? Maybe, maybe not. Most companies would take total hours and wages and divide each by 52 weeks for an employee like this. But wait, what if the employee did not work during the summer of 2022, for whatever reason. If the wages and the hours are reduced because of an absence but the denominator is 52 because of the bounding data points, then the average weekly wages and hours would be diluted. If, however, rather than simply taking the weeks that the employee was “employed,” the weeks actually worked were used, then a vastly different result might occur. Understanding this “donut hole” in the work schedule of employees is critical to ensuring the best result. Some employees have multiple donut holes when companies call in employees during busy times and not during slow times. Having reviewed countless payroll files from companies, it’s true!

Hire dates and term dates come into play as well, which is why using them can be a problem. Some companies re-hire the same employee over and over. The data might even show a term date before a hire date which is weird, but data can be misleading. Unless the person calculating the employer tax credit has full access to the individual’s Human Resource file, they may never know the exact history. Furthermore, term dates can occur weeks or months after the employees last day of work. Again, using the term date as an outer bound for the calculation can cause significant dilution by over-inflating the denominator of the equation.

What should you do? Count the pay-periods that the employee in fact worked. This too can be a little deceiving. Many employees get a paycheck weeks or months after their last day of actual work. This tail payment can stretch out the timeframe or inflate the pay periods by a lot. As such, using only pay periods that have hours associated with them is a start. If unused vacation or sick time is reflected as hours worked, then it may need to be manually reviewed.

For some reason, some payroll companies generate a zero hour, zero wage record if the employee is not actually terminated. These “phantom records” can throw a curveball into the calculation as well, if treated like a period of work.

Eligible Pay

To make matters worse, pay cycles can differ by employee and can be a real challenge. Companies that pay commissions, for example, often run a regular pay cycle but may also run a commission pay cycle. The commission pay cycle is oftentimes bounded by the dates the commission was earned. For a car dealership as an example, if an employee sells one car during the week the pay cycle is one day. If they sell a car on Tuesday and another on Thursday, the pay cycle is three days and so on. Understanding all these nuances is critical when maximizing the averages and almost every company has some sort of idiosyncrasy to contend with. Payroll is anything but uniform from company to company, trust me.

To address the pay cycle problem and use pay periods as a guide to developing the most accurate denominator, count only pay periods with hours associated with them and then determine the number of days that each pay period contains but disregard any double counted days in overlapping pay periods. It sounds more complicated than it is. Take the number of days worked, divide it by 7 and you now have actual weeks worked. The sum of all wages paid, assuming a gross wage base requirement, is always the same if paid within the applicable year.

Outliers When Calculating

Outliers will exist and need to be looked at. If they are material, they can be addressed manually. Did an employee really work 300 hours in a weekly pay period? Did they really make in $10,000 in a week? Why did they get paid for weeks and weeks without any hours? Was it workers compensation? What’s the pay-code for that? Is that visible in the data? Those are just two examples of many.

The oddities will be there and should be assessed even if they can’t be rectified. There is always a story behind the numbers, but without access to the HR system or bugging HR for the answers, it may be impossible to know.

As stated earlier, a penny off or a minute shy can mean the difference between an eligible and an ineligible employee. Employer Tax Credit and Incentive Compliance is not a game of horseshoes, but you can often move the target with a little more analysis!

Another area of opportunity does involve hire dates and term dates. As stated earlier, these can be suspect, but for most companies at least the hire date can be relied on. Take for example a company that pays employees every two weeks or twice a month, where the pay cycle is relatively long. If you see employees with pay period start dates significantly before hire dates, that is an opportunity to “trim” the pay period by several days, which in turn reduces the denominator used in the wages and hours per week fractions.

It might be just enough to get that missing penny or minute needed to qualify an employee for the credit.

On the backside, if a term date is prior to a pay period end, a similar “trim” can occur and might get you that penny or minute.

If, however, employees have breaks in employment during the year where pay period hours are significantly smaller than a normal pay cycle would have been, it’s almost impossible to determine an exact adjustment that should rightfully take place, so it’s usually ignored. An analysis of time sheet information, if available, could answer this question but doing so doesn’t seem practical with large number of employees where lots of employees have “donut holes” in their annual pay cycles that need to be “trimmed”.

The answer is out there and finding it is likely beneficial.

Improving Compliance to Maximize Credits and Incentives

In summary, whether it’s negotiating the deal up front with better knowledge of what the compliance will entail or understanding the data used to calculate performance, spending more time understanding both will undoubtedly pay significant dividends for the company that takes the time to do so. Stay tuned for more to improve your employer tax credit and incentive claims

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