The R&D tax credit is a federal credit aimed at encouraging business investments in technological innovation. In 2015, with the Protecting Americans from Tax Hikes Act, the R&D tax credit was made permanent, giving qualifying companies a chance to plan to take advantage of it.
“The credit offers companies the benefit of a percentage of expenditures for qualified R&D activities, which hinges on how much businesses invest in R&D,” says Monika Diehl, tax director at Clarus Partners. “Unfortunately, not all that qualify take it.”
Smart Business spoke with Diehl about the R&D tax credit and the qualifying activities it’s designed to encourage.
Are many companies that qualify for the R&D tax credit taking advantage of it?
Many companies are not taking advantage of the R&D tax credit. The low use is often attributed to lack of awareness that credit is out there and not understanding what activities qualify. There also had been a barrier to use because calculating the credit for many years was cumbersome. That has improved in recent years.
Previously, the process to calculate the credit required a comparison of current year qualifying activity against activity dating back to the creation of the credit. The option to use a simplified method was introduced several years ago. The simplified method compares the current year investment in qualifying activities to the same investment for the average of the previous three-year period, making it a lot simpler to get the information necessary to take the credit.
An R&D study is needed to document that a company’s specific activities qualify, so there is some time involved there.
What are some common misconceptions around the R&D tax credit that stop companies that qualify from pursuing it?
One of the main misconceptions about the R&D tax credit is that businesses mistakenly think it’s only applicable to activities performed in scientific environments, such as in a lab. That’s not the case. The credit applies to businesses in all types of industries and to a variety of activities that are technological in nature. There does need to be some component of uncertainly and a trial and error process to solve for some unknown, but this can be done in a typical business environment.
Some examples of qualifying activities are developing new products or product formulas or developing processes. These activities are conducted in many businesses, not just those considered to be highly scientific.
For companies that want to take advantage of the R&D tax credit, what should they know?
Recent changes in the law are making it easier for business activities to qualify for the credit and for smaller businesses to realize benefits.
The cost of research required to develop software primarily for the company’s internal use has historically, and under recently revised rules, been subject to meeting very specific guidelines in order to qualify. However, new guidance narrows the definition of Internal-Use Software allowing more projects to be considered under a more relaxed standard.
Recent changes are also helping smaller businesses benefit from the R&D credit. Eligible small businesses can now apply the credit against regular tax and the alternative minimum tax. Previously the benefit was available against the regular tax liability only. There is also an opportunity for qualified small businesses to apply the credit against payroll tax on employee wages. These changes provide smaller businesses with a cash benefit more quickly.
As with a lot of credits, businesses often don’t know they exist or what activities qualify. There are a number of helpful credits not only at the federal level, but also from the state down that encourage businesses to undertake certain activities and make certain investments. When investments are made that grow and improve a business and create jobs, governments frequently offer incentives to assist with costs through grants, tax credits, special financing arrangements, or reimbursement of costs to train new employees. Keep an eye out, because there is likely help available for those willing to look for it.
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