Most companies are aware of the existence of research and development tax credits, but many make the mistake of thinking they can’t take advantage of them.
“There are a lot of small and medium-sized businesses that have the perception that the credit doesn’t apply to them,” says Joe Werstuik, manager of the tax department for Saltz, Shamis & Goldfarb. “Even if they are just a pass-through entity, they can still take advantage of the research credit.
“They often think that it’s only for companies with big labs like GM or the big pharmaceutical companies that are developing sophisticated drugs or that type of thing. They don’t think the activities they do on an everyday basis would qualify.”
The credit is generally 20 percent of qualified research expenses for each tax year.
“This credit is a dollar-for-dollar reduction of your tax liability,” says Werstuik. “It ends up being a cash savings to the company. It does not reduce the taxable income, it actually reduces the tax liability.”
So a $1,000 earned credit, for example, would mean you deduct $1,000 directly from your tax bill, not just reduce your taxable income by $1,000.
To claim the credit, you must meet all four of the following requirements.
* The research must be technological in nature.
* It must have a permitted purpose. This means you have to be doing something to improve the function, reliability or quality of a product or process.
* It must have uncertainty testing. This means you are developing hypotheses on how you are going to solve your particular problem.
* It must have a process of experimentation. You have to be evaluating different hypotheses and going through a trial-and-error process.
“If you already have a product in commercial production, the things you do after production would not qualify,” says Werstuik. “Quality control, for example, does not qualify.”
The rules to claim the credit can be tricky. A product in commercial production may not qualify, but if you were re-engineering the entire production line, you could most likely claim the credit for improving the overall process.
“That’s different from a machine is running, and knocking every 10th bottle off the line,” says Werstuik. “It’s only if you are effectively re-engineering the whole process that it would qualify.”
Documentation is required to prove you have met the requirements and can associate all the costs with the research.
“There can be a lot of paperwork involved,” says Werstuik. “You have to document the activities, look at the costs associated with the activities and associate the costs with those.”
Costs associated with raw materials, jigs, prototypes and even outside consultants can qualify. Wages of those involved in the research and testing and the first layer of management can also be factored into the costs in most cases.
Because of the documentation requirements, not every company that could claim an R&D credit is going to want to, because the return doesn’t always justify the costs. Werstuik suggests having a high-level consultation with someone with expertise on the issue who can do a rudimentary examination of your research activities to estimate what the benefit might be.
It is possible to do it all in house, but the complexity of the code may keep you from getting the full benefit.
“A lot of times, if the company does it in house, they are not fully apprised of the nuances that go with the research credit,” says Werstuik. “They tend not to qualify certain activities or don’t pick up the right costs or as much as they probably could. If you bring somebody in that is familiar with the code, your chances of getting a larger credit are greatly enhanced.”
How to reach: Saltz, Shamis & Goldfarb, www.ssandg.com or (330) 668-9696
While a wide variety of activities can qualify for the Research and Development Tax Credit, many do not, including some you might initially think would make the cut.
Activities that do not qualify include:
* Activity relating to management technique, market research, market testing or market development
* Conducting efficiency surveys
* Duplicating an existing component via reverse engineering
* Research after commercialization
* Activities relying on the social sciences, arts or humanities
* Routine data collection or ordinary testing for quality control
* Manufacturing support activity
* Activity conducted outside the United States
Conducting research in an area that qualifies doesn’t require success to claim the credit.
“Companies often think that the research has to be successful to qualify for the credit,” says Joe Werstuik, manager of the tax department for Saltz, Shamis & Goldfarb. “Actually, failures are good, because having some failures along the way provides evidence that you are doing qualified research.”