There are certain tax benefits that businesses naturally tend to take advantage of, such as the business meals deduction. In contrast, the Research and Development (R&D) tax credit is taken by only 1 in 20 small-to-medium-sized companies that are eligible. Furthermore, recent changes in R&D tax credit regulations have increased the number of businesses that qualify for the R&D tax credit. For example, your company may be eligible if your business improves products or processes.
The R&D tax credit was created in 1981, and remained temporary over the next 35 years, periodically expiring (sometimes for up to year) then being extended by Congress retroactively. In 2015, the PATH (Protecting Americans from Tax Hikes) Act made the R&D tax credit permanent.
The PATH Act also added a startup provision and an AMT (Alternative Minimum Tax) turnoff feature. Previously, startup companies could not utilize the R&D tax credit because they were not paying federal income tax — they did not have a tax liability to offset the credit. The new startup provision allows startup companies to take the R&D credit against payroll taxes. The AMT turnoff feature is a key change, as it allows small businesses with less than $50 million in average gross receipt for the previous three years to take advantage of the R&D tax credit.
The R&D tax credit used to only be allowed on originally filed returns. For many small and medium business owners, qualifying for the R&D tax credit for one year was not worth it. In 2014, regulations were passed allowing the R&D tax credit to be claimed on amended returns. Business owners can now amend the last three to four years of open tax returns, making the qualification process worth the effort.
Approximately 80 percent of the current R&D tax credits go to a few of the nation’s largest companies (source). However, companies of any size are eligible for the R&D tax credit and many small-to-medium-sized businesses are missing out. Why? Self-censoring is currently the biggest road block preventing businesses from taking the R&D tax credit. Many think they do not qualify for the credit because they believe it only applies to companies with employees in white lab coats who work with test tubes. Business people regard their efforts to make new or more versatile products as “just doing my job,” when in fact they have been performing R&D qualifying activities.
R&D Qualifying Activities
Companies that design, develop, or improve products, processes, techniques, formulas, inventions, or software may be eligible for the R&D tax credit. While the credit isn’t industry-specific, some of the common industries that qualify are Manufacturing, Architecture, Engineering, Construction, and Software/Technology. If a company is eligible for the credit, then generally all R&D expenditures related to the development or improvement of a product can be deducted, with the exception of specific activities such as quality control or advertising expenses.
If your company qualifies, the R&D tax credit can be substantial, up to 13.5 cents of credit for every qualified dollar. Below are some additional benefits:
- Credits for the last three-to-four years of open tax returns can be claimed by filing amended tax returns.
- If an R&D tax credit cannot be fully utilized in the current or previous years, it can be carried forward 20 years.
- Most states also offer R&D tax credits, including Maryland and Virginia.
Keep in mind that a tax credit provides a dollar-for-dollar reduction of income tax liability compared to a tax deduction which lowers taxable income. Therefore, the R&D tax credit can be an immediate source of cash for your business.
CST Group works with R&D tax credit specialists that can evaluate if the R&D tax credit applies to your business. These specialists charge fees only if they determine that your business is eligible for R&D tax credits that you are not currently utilizing. If your business improves products or processes, consider an R&D tax credit evaluation to see if you qualify for an R&D tax credit.