Are You Taking Advantage of the Largest Tax Credit Available to US Businesses?

I was shocked when I read that the Wall Street Journal that experts estimate 95% of eligible companies are not taking advantage of the largest tax credit available to US businesses: the Research & Development (R&D) Tax Credit. As a former controller and cost accounting manager for a $6B Fortune 500 Company, I made a career out of squeezing every dime possible from taxes and spending. Failing to exploit the potential benefits presented by Research & Development Tax Credits is like turning down free money.

How can this be that so few companies are benefiting from this credit?

Why wouldn’t businesses jump at the chance to benefit from an IRS sanctioned opportunity to gain a competitive edge? 

To understand why not, the best place to start is with some context.

What are R&D Tax Credits?

Originally intended in 1981 to keep high-paying technical jobs here in the U.S, they have expanded over the years to reward innovation. The scope and nature of the tasks of employees are examined, and activities that meet the IRS definitions of improving products, processes, formulas, inventions, software or technique may qualify for a tax credit.

Eligibility is determined by the nature of the activities performed, not by transaction, industry or company size.

Why should a company consider the R&D Tax Credit?

• The federal government wants you to take the credits. Because R&D activity does not directly lead to an immediate sale, the government wants to encourage the forward-thinking, big-picture efforts that will pay off later down the road, which promotes long-term economic growth.
• State governments want you to take the credit as well. As of this writing, nearly 40 states also have a state level R&D credit. Therefore, if you qualify for the federal credit, there is a great chance you qualify for additional state credit as well.
• The 2016 TCJA tax laws eliminated several tax breaks for businesses, but the law made R&D credits permanent. Previous uncertainty caused by annual renewals may have caused some companies to hesitate to apply for R&D tax credits. Hesitate no longer.
• Eligibility for R&D credits has expanded over the years. More activities are now eligible for the credits than the original code allowed, thanks to developments in technology.
• Over $11B in federal R&D Tax credits were claimed in 2013 (the last year data is available) The potential savings for companies that file for the credits are not trivial. R&D Tax Credits are the largest tax credit available to US businesses.
• Your competition is benefiting from these incentives. Not just in the US. Despite the large amounts of taxes saved by US companies, other first world countries offer much more generous incentives for research and development than the US does for the same reasons: to reward innovation. If a US company wants to stay competitive in the US but especially globally, they would be wise to consider taking another look at R&D Tax credits.
• The 2015 PATH Act allows startups to claim credits even if they have no revenue. Additionally, any credits that can’t be used to offset income during the year claimed can be carried forward up to 20 years.

Hopefully, you can see by now that there are many reasons why a company should consider claiming the R&D Tax credit. So why do only 5% of eligible companies claim them? 

The number one reason companies do not choose to apply for R&D Tax Credits: Businesses do not think they qualify, so they decide not to proceed.

This can be a dangerous decision. Executives should take care not to decide whether they qualify or not unilaterally. Too often, company management doesn’t realize their work may qualify.

Eligibility is based on activities performed, not by industry or size of the company. How do I know if my company qualifies?

You may be eligible for the R&D credit if your company engages in any of the following activities:

• Devotes time and resources to creating new innovative products
• Improves existing products
• Develops processes, patents, prototypes or software
• Hires designers or engineers

Due to the nature of the work, the most represented industries claiming R&D Tax Credits include:

• Manufacturing
• Semiconductors
• Architecture/ Engineering/ Construction
• Aerospace & defense
• Software
• Finance
• Transportation
• Life sciences including pharmaceuticals and medical devices
• Food and beverage services and processing
• Wholesale and retail trade
• Holding companies
• Arts & entertainment
• Chemicals and plastics
• Energy
• Automotive
• Telecom
• Agriculture, forestry, fishing, and hunting

The list goes on and on. Don’t worry if you don’t see your industry listed. At the end of the day, any company in any sector can qualify for the R&D tax credit if they can prove they perform R&D activities.

Most people associate R&D credits with people in lab coats using microscopes. The IRS definition is broader than you may think. R&D by the IRS definition includes making a new or existing product better, faster, quicker, lighter, cheaper, more durable, more reliable, more precise, greener or cleaner. 

Since more companies have increased technology and automation within their processes, more and more companies are now qualifying for R&D credits when they may not have in the past. Businesses are doing more in-house activity that may qualify than they think. In many cases, if a risk of loss exists relating to the designs, these costs may qualify for the credit as well. Some examples are:

• An architectural engineer developing building fabrication systems
• An agricultural engineer evaluating soil samples
• An environmental engineer deriving methodologies for resolving ground contamination
• Attending technical meetings in which specifications, concepts or results are discussed
• Providing feedback to senior management regarding the ongoing research activities
• Project planning
• A technician calibrating research equipment
• A clerk typing technical reports
• A maintenance worker cleaning up following an experimental process test

Most companies do not make the exact same products the exact same way all the time. Any company that innovates and improves should at least consider claiming R&D Tax Credits

Let’s look at some other common misconceptions about R&D Tax Credits

· It’s not worth the time. Based on the amount of savings possible, including the fact that most states allow for credits as well makes the effort justified. Also, the credit can result in cash back for the previous three tax years and can also represent future savings, as they can be carried forward up to 20 years.

· My company does not invent anything. As I have demonstrated, inventions are not the determining factor in qualification. The credit is designed to be a driver of improvements and innovation. Even if a project fails, it may still qualify.

· We are not performing activities that qualify. As long as companies are attempting to develop new and improved products, product lines, manufacturing processes, or software, they could be eligible. When in doubt, consult an expert before unilaterally writing off an activity.

· Why doesn’t my CPA do this? R&D Tax Credits are outside the bandwidth of most CPAs. Not only are they buried by 72,000 pages of IRS tax code, but the R&D credit rules have also constantly been evolving. Many CPAs may not be up to date with the latest changes.

Who can help get your R&D credits

Similar to your health care provider, who you go to for annual physicals, prescription refills or a sore throat, you go to a specialist if you have a heart issue or you blow out your knee. Due to the complexity of the tax code involved with R&D credits, I recommend a company work with an R&D credit services provider. Here’s what to look for when selecting an R&D credit services provider:

1.  Do they have sufficient experience performing R&D credit studies?
2. Do they have tax-experienced CPAs on staff who focus primarily on the R&D credit and it’s benefit to each shareholder?
3. Do they have a documented approach that includes spending time with your staff?
4. Do they stand by the claim in the event of IRS or state appeals
5. Do they charge a fixed fee (in accordance with Circular 230) vs. charging a percentage of savings?

And the cost? Costs are based on the complexity of the case. Generally, the benefits are 3X-6X the cost of the study.

The lesson here is not to write off exploring whether your company may qualify for R&D credits. The US government wants to reward you for your efforts, and you should see if you qualify because your competition surely will.

What is the cost to you to not move forward with R&D credits today?

Murray Beaulieu

CEO Boosted Profits

About the author: Murray Beaulieu’s career as a Controller and Cost Accounting expert with Fortune 500 companies spanned over 35 years. Over that time, he and his teams saved millions of dollars in spending and taxes. Now, Murray is passionate about leveraging his experience and a team of world class experts to make sure small and medium sized businesses are not leaving money on the table.