Posted by Jeffrey Feingold on 07.31.24
Federal and state R&D tax credits provide an outstanding opportunity for innovative small and medium businesses to keep more of their hard-earned dollars. However, less than 33% of companies that qualify for the federal R&D tax credit actually utilize it, due to misconceptions about qualification and the complexity of necessary documentation. The following answers set the record straight.
1) Only a company with patents, or unique products, qualifies for R&D tax credits.
The tax code has been changed so that a company developing new products or processes, or improving existing ones, can qualify. Job shops that engineer and manufacture custom products and processes, typically qualify, too.
2) Only a company with staff in lab coats working with test tubes can qualify for R&D tax credits.
The tax code was changed to expand the definition of R&D from only laboratory science to sciences applied in the field. Many job shops, engineering service firms, and other companies now qualify.
3) Only a company with profits and a current tax liability should claim an R&D tax credit.
Even if a company has no current tax liability, federal R&D credits can be carried forward for up to 20 years for use in reducing future tax liability, and the credits can also be retroactive for the prior three years. State carryforwards are different—in some states, the tax credit can be carried forward indefinitely.
4) Only a company with federal tax liability should claim an R&D tax credit.
About 40 states have state R&D tax credits, some with advantages not offered by the federal R&D credit program, such as: ability to sell or transfer the credits, ability to get a state refund when the credit exceeds state tax liability, and, in some cases, credits which can be as much as four times the federal amount.
5) Only big corporations can claim an R&D tax credit.
The U.S. tax code has been changed to make R&D credits more easily available to small and mid-size companies, and about 25% of all companies claiming the credit have assets under one million dollars. The enactment of the Protecting American from Tax Hikes (PATH) Act of 2015, which made the federal R&D credit program permanent, includes a new provision that enables startups, as well as some established small businesses, to qualify for the tax credit. Qualifying small businesses can elect to use part of the current-year credit or even a carryforward credit against the payroll tax.
6) A company manufacturing in China or elsewhere overseas can’t claim the R&D tax credit.
As long as the design work is done here in the U.S., manufacturing of this product can occur anywhere, whether the manufacturing is outsourced or the manufacturing company is your own
7) The R&D credit won’t help cash flow or profits.
Unlike a tax deduction, an R&D tax credit is a dollar-for-dollar credit; this reduces a filer’s tax bill by a full dollar for each credit dollar. A six-figure tax credit – which most of our clients receive – increases earnings after tax by the full amount of the credit. A tax credit that can be used to reduce the taxes to be paid means that much more cash in the company’s bank account.
8) Every company claiming an R&D tax credit gets audited.
Tax Point Advisors’ audit rate is under 5%.
9) Only companies that have been in business for a long time can qualify.
The enactment of PATH enables startups, as well as some established small businesses that develop and test new products to qualify for the R&D tax credit. Before, a company had to generate a profit and pay income taxes before it could claim the credit. Now, businesses with less than $5 million in revenue a year can take the tax credit against their payroll taxes, assuming they had employees engaged in research and development within their first five years in business. The maximum benefit an eligible company is allowed to claim against payroll taxes each year under the new law is $250,000.
10) As a shareholder of an S corporation, I pay Alternative Minimum Tax (AMT); R&D tax credits can’t reduce my tax burden.
The Protecting American from Tax Hikes (PATH) Act of 2015 included a provision to make it possible for companies with $50 million and less in gross receipts, based on a three-year average, to apply the R&D tax credit against the AMT. That means shareholders of qualifying pass-through entities, such as S corporations and partnerships that have an AMT liability, can apply the offset following carryforward and carryback guidelines. The new AMT provision is effective Jan. 1, 2016 and later.
Find Out if Your Activities Qualify
The R&D tax credit can be a lucrative incentive for innovative businesses. Given the new permanent nature of the tax credit, now is the time to consider whether activities performed by your company qualify for major cash-saving tax credit opportunities. To learn more about whether your industry and company activities meet the R&D four-part test, request our free assessment today.
Tax Point Advisors, a firm with expertise in working with small and midsize companies, works with businesses that may qualify for R&D tax benefits. For more information, please contact (800) 260-4138 or please leave us a message below.
