Companies of all sizes in dozens of industries are taking advantage of tax savings. Chances are you qualify. See simple 4-part test.
By Chris Bird
Companies spend enormous amounts of time, effort and money looking for ways to cut costs, streamline operations and maximize their bottom line. But sometimes the biggest cost savings are right under our nose and it doesn’t take powerful software or armies of consultants to find it.
Have you considered the Research & Development (R&D) Tax Credit? If you think it’s only for engineers, drug makers and tech startups, think again?
Companies of all shapes, sizes, ages and industries are taking advantage of generous tax savings from the day-to-day operations. If your company is developing new or improved products or processes, chances are it will be eligible for R&D credits. You just have to meet the IRS’s four-part test below:
- Qualified Business Component. The activity must include, but is not limited to a new or improved product, process, formula, computer software, program, technique or invention
- Technological in Nature. The activity being performed must fundamentally rely on the principles of physical science, biological science, computer science or engineering.
- Eliminate the Uncertainly. The activity must be intended to discover information to eliminate uncertainty concerning the capability or method for developing or improving a product or process or the appropriateness of the product or process design.
- Process of Experimentation. The experimentation process needs to include the evaluation of alternatives. Examples of acceptable process include systematic trial and error, computer aided modeling, and simulation in an effort to resolve the technical uncertainty.
Once the above requirements are met, expenses associated with those development activities can be included in the credit.
Brief history of R&D credits
Introduced back in 1981, the R&D Tax Credit is a government-sponsored tax incentive that rewards companies for conducting their R&D activities in the United States rather than offshore. The credit is designed to incentivize innovation throughout the U.S. economy and to keep technical jobs within our borders. Thanks to numerous modifications and expansions over the years, more companies than ever can benefit from this valuable incentive. Why leave money on the table?
Common misconceptions about qualifying for R&D credits
- The project failed. We won’t qualify. Not true. The project does not need to be successful in order to qualify for the R&D credit. If it becomes clear to the company that meeting its project goals will be too costly to pursue, or if the end product will likely be too large, expensive or heavy to continue, then the project can be terminated without losing out on R&D credits. You simply tally the qualified costs up to the point of termination and include those in your company’s R&D credit calculation.
- We don’t quality because we have no federal tax liability. The PATH Act of 2015 (Protecting Americans from Tax Hikes) made the R&D credit permanent and made it easier for smaller businesses and startup companies to utilize the credit because they could now apply their R&D credits against their payroll tax—not just their profits. To qualify, an early stage company must simply meet the following two criteria:
a) Have no more than five years of gross receipts.
b) Have generated less than $5 million in gross receipts for the year claiming the credit.
Over my career, I have helped many startup software companies claim R&D credits and apply those credits against their payroll taxes—even though they didn’t have federal taxes due, or gross receipts for that matter. Applying R&D credits to your payroll taxes can occur as soon as the first quarter after the quarter in which the tax return that claims the credit is filed. - We’re not engineers, drug researchers or software developers. Fine. All types of companies are now successfully utilizing R&D credits. I once assisted a metal recycling facility with its R&D credit. While you don’t typically think of a scrap yard doing big things in innovation, this company determined that its process for separating different metals (their qualified business component) wasn’t performing well enough. The company wanted to develop an improved automated separation process using magnets, air and multiple sensors (technological in nature). Unsure that this process would meet its requirements, (technical uncertainly), the company they tried various means of separating the different items. Employees experimented with gravity flow, conveyors, air nozzles and electromagnets (process of experimentation) until they met the company’s process requirements. Chances are you have processes that qualify, too.
- We don’t maintain supporting documentation of our R&D or track our employees’ daily R&D activities. According to the IRS, supporting documentation of R&D activities must be maintained in order to support your credit claims. But the Service provides no other guidelines about the types of documents required or how much documentation is needed. If you can provide test reports, drawings or blueprints, value stream maps, project review presentations, financial records, and invoices for qualified expenses, you’re chances of qualifying may be good. When it comes to tracking employees’ qualified R&D time, the IRS would love to see time tracked on a daily basis. However, it understands that most companies don’t do that and allows you to estimate their time as long as the supporting documentation exists to support your estimates.
This is one of the trickier areas of the R&D credit program. We can help you implement an appropriate tracking procedure or other system to determine qualified time without disrupting your day to day business activities.
Conclusion
If your company is developing a new or improved product or process, it is very likely that you will qualify for an R&D credit. We can assist you in determining the size of your credits, the usability of those credits, and the appropriate method for supporting your credit claims. Contact us today.
Chris Bird is a senior director-engineering services at Tri-Merit, a specialty tax provider that partners with CPAs and their clients to optimize R&D tax credits such as engineering-based incentives. For more than a decade, Tri-Merit has specialized in tax credits and incentives. The firm’s partners speak often at accounting industry trade shows and conferences to help educate the profession. Contact Chris at cbird@tri-merit.net | 847 637 5677 x.
