The Research & Development (R&D) Tax Credit is a government incentive available to compan...
There are many myths about the R&D Tax Credit, and these misconceptions often cause business owners to believe they don’t qualify or won’t be able to benefit. In reality, the R&D Tax Credit legislation is much more inclusive than people realize – almost any company can benefit regardless of industry, size or age.
Here are 5 common myths about the R&D Tax Credit and one that has emerged with the spread of COVID19:
The IRS defined R&D through a 4 Part Test and, surprisingly, the definition is incredibly broad. As long as a company is in a field of hard science and trying to either improve an existing product/process or develop a brand new one, they are likely conducting an R&D project.
While it is true that scientists in white lab coats working in the biotech/pharmaceuticals space are doing significant R&D, building a new software platform, designing a building and altering a recipe to improve shelf-life all require R&D too.
Not anymore! The Protecting Americans from Tax Hikes (PATH) Act had some very impactful changes on the R&D Credit in 2015 as it introduced a version of the credit that was specifically designed for startups or companies that haven’t had any revenue.
One of the earliest expenses a startup will incur is payroll and, therefore, payroll tax liability. The startup-specific R&D Credit allows qualified small businesses to recapture a percentage of their R&D investment to reduce payroll tax liability.
Historically, larger companies were more likely to claim because they had the resources, whether internal personnel or capital to outsource, to have a thorough R&D Credit study completed each year. Since the PATH Act made the credit permanent, these large companies are incentivized to continue investing in US based R&D to capture this credit on a yearly basis.
Now that this is a permanent incentive, the government wants businesses to be taking advantage of the R&D Credit so, it does not automatically raise a red flag with the IRS.
Although claiming the credit is not an automatic audit flag, the possibility of an audit still exists and this makes it crucial to have proper documentation available to support the claim.
Ordinary business documentation is a good starting point to support your claim during an audit, but part of a successful audit is to understand how to answer the IRS questions. As an example, the IRS doesn’t only want to see the steps taken during the experimentation phase; they want to understand why there was a need to go through a process of experimentation and what the technical challenges were that you were attempting to resolve.
More than 30 states offer their own version of R&D Tax Credit and most state credits closely follow the Federal legislation, Section 41. However, some states have also set their own requirements. For example, Colorado requires a business to be located in an Enterprise Zone and Pennsylvania allows businesses to transfer (effectively sell) their credit. The state credits are in addition to the federal tax credit. Depending on the state, this could potentially double a company’s tax savings.
The R&D Credit is a technical, project-based credit, meaning you need to identify the projects that pass the 4 Part Test before you can identify your R&D investment and ultimately calculate the credit. Involving technical expertise in the R&D Credit study process ensures that each project is accurately qualified, including projects with evident R&D as well as those with R&D that is a little less clear-cut.
With over 20 years of experience in the innovation funding space, Leyton has discovered that taking a dual tax and technical approach to the R&D Tax Credit can increase the value you receive by 40%, compared to the traditional singular approach of tax expertise only. And if you think about it, it makes a lot of sense: Your finance team speaks a very different professional language than your technical team.
Although you might be slowing down your R&D investment in 2020, you still have the ability to claim the R&D Credit retroactively for the past 3 tax years.
Additionally, as you ramp your R&D back up moving forward, a lower level of R&D in 2020 will not hurt your ability to claim the R&D Credit in the future. The formal name of the R&D Credit is The Credit for Increasing Research Activities, which implies that to calculate a credit for the current tax year, you look at your R&D investment for prior years to create a base period. A conservative investment in R&D for 2020 will lead to a lower base period, meaning businesses will likely receive a larger credit in future years.
Would you like to know if your business qualifies for the R&D Tax Credit? Leyton’s teams of highly qualified scientists, engineers,tax accountants, and attorneys are motivated to help your business robustly claim and realize the R&D credit to incentivize further innovation investment. Reach out to us today at email@example.com.