Misconception: R&D Credits are too good to be true - it must be snake oil
Posted by Jeffrey M. Feingold on 02.16.14
Yes, the federal government is reducing taxes for businesses with the R&D Tax Credits. It is true. This is the most lucrative tax incentive out there, and yet only a third of the eligible companies are claiming it. Unbelievable! Is it too hard to understand, too much work to prepare, or too likely to cause an unwanted audit? Let's take a look at the benefits and risks of the R&D tax credits.
- Companies can save hundreds of thousands of dollars by using tax credits against the tax owed and reducing their tax burden.
- This helps the earnings per share dramatically.
- It frees up cash to create new jobs or make much needed capital investments.
- The tax credits are not a use-it-or-lose-it kind of deal. If you can't use all of it this year, you can carry it forward to use next year or later for up to 20 years.
- You may be able to go back and resubmit prior year taxes for a refund. Usually, this is for 3-4 years.
- Many states have enacted R&D tax credits as well, so check your state rules to see that you get tax credits there also.
- Wages, supplies, basic research, and contract research expenses all are eligible.
There is a four part test to determine who qualifies to claim the research and development tax credits.
- The purpose of the project must be to create new or improved functionality, performance, reliability, or quality of a business component or method or process that the taxpayer plans to hold for sale, license, lease, or actual use in the taxpayer's trade or business.
- The taxpayer must intend to find information that would eliminate doubt concerning the development or improvement of the component.
- The results of the process must be uncertain at the beginning of the process.
- The process of experimentation used to discover information must fundamentally be technological in nature, relying on principles of the physical or biological sciences, engineering, or computer science.
- Additional time and effort are required to document thoroughly everything in order to claim this deduction. The benefits are worth it and certainly reap enough to hire extra people to do the documentation.
- Research and Development tax credits are a tier 1 IRS audit concern. The chances of an audit are high. In order to standardize their audit procedures, the IRS developed a standard information document to request information from companies who claim the credit. This request document is looking for information regarding the consistency rule, estimated qualified research percentages for employees, and how much documentation was made. At Tax Point Advisors, our audit rate is under 5%, and our success rate under audit to date is 100%. So although this is a risk, it is one well worth taking.
- Misunderstanding the things that can be claimed in the tax credit is always a concern. The rules are continually changing with the government better defining the original law and with additional laws being passed.
Hire someone who has done this before and is an expert in the field to advise you or to do it for you. Most companies claiming this tax credit hire a specialized tax firm that deals only with the R&D tax credits—like Tax Point Advisors. They will see that documentation is at the appropriate level in case of an audit. They will instruct you what to say and provide if there is an audit. They will also be sure that you are claiming all available expenses.