Recessions are characterized by negative growth in countries’ GDP and a significant slump in economic activity and consumer spending. Such economic downturns impact both small and large businesses, especially if they still have to pay workers and keep up with their tax obligations at the same time despite an unfavorable business climate.
Several tax incentives can cushion businesses against tough economic times, such as the ongoing coronavirus crisis. As businesses throughout the United States struggle with the crisis, R&D can play a critical role in spurring economic growth. R&D tax incentives reward companies for undertaking research and development. Generally, there are two types of incentives that are used to encourage R&D:
- Tax credits
- Tax deductions
R&D tax credits act as buffers that help lower your company’s tax liability. They can also become refundable if no tax is due. Since they directly offset your tax liability, R&D tax credits can be even more valuable to you than typical tax deductions. In America, more than 20 states offer tax credits over and above the federal tax credit.
The R&D tax credit is meant to help businesses of all sizes and not just big corporations that have research labs. If your company is involved in any of the following activities, you qualify for the R&D tax credit:
- Designing or development of new processes or products
- Improves existing processes or products
- Improves or develops existing software or prototypes
Claiming the R&D Tax Credit
Several factors should be considered before claiming the R&D tax credit. Nonetheless, the potential savings make leveraging the credit a worthwhile investment. You can claim the credit for prior tax years as well as the current tax year. Companies should document their R&D activities continuously since this puts them in a position to claim the credit.
Evaluating and documenting your company’s R&D activities helps you to establish the expense of each research activity. Although taxpayers can estimate some of their research expenses, they need to have a factual basis for any assumptions that they use to come up with the expenses. Some of the documentation required to make an R&D tax credit claim include:
- Payroll records
- Project lists
- General ledger expense details
- Project notes
When these records get combined with credible testimony from your employees, they form the basis of your R&D tax credit claim. If your company is claiming the credit already or you want to determine your eligibility status, you should be methodical when evaluating and documenting research activities for future R&D tax credit claims.
Failure to do so puts you on the radar of the IRS. You are also likely to see your credit claims getting disallowed. Sometimes, companies tend to think that they don’t qualify for R&D tax credits. Common factors that might make you have this mindset include:
- Failure to pay federal income tax. Startups and SMEs can apply up to $1.25 million in R&D tax credit (or $250,000 annually for five years) to offset the FICA portion of annual payroll taxes. To quality, the companies must have gross receipts worth less than $5 million.
- Not focused on R&D. Companies that don’t own R&D laboratories but still undertake R&D or experimentation on their production floors also qualify for the R&D tax credit. Therefore, eligibility isn’t limited to technology companies or companies that have dedicated research departments.
During tough economic times such as recessions, companies should find ways of maximizing their return on research and development investment. R&D incentives such as tax credit claims can cushion your business from the effects of an economic downturn. For more information about R&D tax credits and how you can reduce your company’s risk of IRS penalties, contact the tax professionals at Incentax today.