For many entrepreneurs, day-to-day tasks are marked by notable levels of exploration and innovation. And while a creative spirit is an important quality in a business leader, so is financial prowess. It’s likely that many entrepreneurs are doing work that qualifies for the Research and Development (R&D) Tax Credit and the substantial cash savings it can produce.
So what is this credit, and how can it be used to grow your business?
The R&D credit is a business tax credit that generates thousands -- even millions -- of dollars in savings for companies of all sizes and industries, e.g., technology, finance, manufacturing, agriculture, healthcare, social assistance services and many others.
Entrepreneurs, who often need to increase cash flow to build and scale their businesses, should be particularly attuned to how they can reduce their federal and state tax liabilities. And for entrepreneurs who aren’t yet paying taxes, these credits can be carried forward and used in later years when taxes may be due. In many states, too, these credits can provide entrepreneurs a benefit now, even though no taxes might be due, because those states offer refundable or transferable credits.
What qualifies for the credit? If you are developing or attempting to develop new or improved products, processes or software, your activities may be eligible. The wages paid to employees for performing, directly supervising or directly supporting these kinds of activities, as well as certain contractor and supply expenses could also be eligible.
Despite the possibility of substantial benefits, many companies still aren’t claiming the R&D credit. This may be due to some common myths, debunked below.
1. We’re too small to have a credit worth pursuing.
Actually, corporations with sales between $0 and $25,000,000 reported more than $360 million in federal R&D credits in 2012.
2. We need to be doing groundbreaking work to qualify.
Groundbreaking activities likely qualify, of course, but the level of technological advancement undertaken or achieved generally isn’t relevant to eligibility. As long as a company attempts to develop a new or improved product, process, software, technique, invention or formula, the activity could be eligible.
3. Most of our qualified work is done by our CEO and VPs, and executive-level employees can’t do qualified research.
This isn’t true: Job titles and department assignments do not affect eligibility. Rather, eligibility is based upon what employees actually do. The U.S. Tax Court recently affirmed this, upholding as qualified 75 percent of a CEO’s time as qualified and even higher percentages for other executives. In that case, the executives’ qualified time included time spent in strategy meetings brainstorming new ideas, following up during the product development process, and reviewing and signing off on new or improved design specifications.
4. We don’t have the required documentation.
Although tax examiners may request time-tracking and project-accounting records, as well as documents about the development activities in question, most taxpayers don’t have the former, and sometimes have very little in the way of the latter. Several court cases, fortunately, have upheld the principle that oral testimony can be relied upon to establish a taxpayer’s credit, provided the testimony is reasonable under the circumstance.
5. We lost the chance to claim credits because we haven’t claimed any in the past.
There’s no requirement that credits be claimed in past years to claim one in the current year. Moreover, if you find you do have credits in earlier years you can amend your tax returns to claim them for at least the last three tax years. If you couldn’t have used credits in earlier years because, e.g., you were in a loss or alternative minimum tax position, you don’t even need to amend your returns -- you can simply report them on a credit carry forward schedule going back as many as 15 years.
6. We don’t qualify because we’re developing software only for our own internal use.
Internal-use software (IUS) development actually can qualify, and recent IRS regulations helped clarify, in a taxpayer-friendly manner, what is and isn’t IUS.
For many entrepreneurs, tax considerations and planning may not be top of mind. Don’t let the myths above deter you from discussing with a tax professional the savings opportunities the R&D tax credit can generate.