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.
American companies are spending more on Research and Development each year. The National Science Foundation shows sustained increases in research and development expenses in the US in the years after the 2008 financial crisis, meaning, American companies are trying to innovate and put their money where their mouth is.
Yet small and medium business owners hear the words “research and development” and they probably envision something outside of what they and their teams are doing on a daily basis.
When business owners hear “R&D tax credits” it’s easy to think that you need to have a huge department doing rocket science each day and invent the next huge thing to even be considered as a business that does Research and Development.
Well, R&D tax credits are one of the areas in tax incentives where the little guy can benefit too. Advocates for the R&D tax credit believe the government could do a better job at educating business owners, regardless of the size, on the tax credits they could be taking advantage of and aren’t.
What is an R&D Tax Credit and What is it Trying to Get Companies to Do?
What these tax credits are trying to do is incentivize companies through a tax break for doing Research and Development work in the US. Notice, we’re not even saying Research and Development that works. We’ll get to that in more depth in a bit. The goal is to keep more jobs in the US and reward companies that are trying to innovate.
What kind of activity qualifies as Research and Development?
Any activity in your business that involves design, development, and improvement of a product and/or a service may qualify as R&D. In fact, in 2003, the “Discovery Rule” that was part of this tax credit was removed; instead of having the R&D tax credit only accessible to companies executing research activities “new to the world” the tax credit became accessible to companies executing research activities that were new to them, or an improvement upon what they were doing before.
In 2015, the Research and Development tax credit became permanent, and the profit thresholds necessary to qualify where lowered, meaning that startups that weren’t generating a lot of money, but were possibly generating a lot of innovation could benefit too. You just have to pass what’s known as the four-part test to qualify.
Does my company have to invent something new?
No! You should be able to demonstrate, through documentation your teams are keeping, that the work you’re doing attempts or successfully improves upon a product or service, or develops a new product or service.
What do I need to document to claim it?
You need to document the activities you do as part of your research and development, as well as the expenses those activities require. Some examples of documentation that can help support your claim are project briefings or notes, product descriptions or white papers, payroll records and expense reports.
How small can my business be to qualify for an R&D Tax Credit?
Your business’s revenue has to be less than $5 million in a given year to qualify. You can submit up to five years of evidence as part of your claim and apply it retroactively as far back as 2015.
What about state taxes?
Make sure to check with your state’s Tax Department for applicable credits in your state. Many states have their own tax incentives for Research and Development, but they vary from state to state.
How can I find out more about this and start my claim if I qualify?
Our team of experts at Incentax, LLC knows the tax code in and out and can help you evaluate your individual business situation to find every tax break you can get. Contact us to set up a consultation and learn more about this and other tax credits you may benefit from.