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Research and Development Tax Credit

research and development tax credit

R&D Tax Credits: An Added Benefit to the Next Relief Package?

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A frequently overlooked tax deduction for businesses big and small is R&D tax credits. R&D stands for “Research & Development” for any business that managed such activities in the last year or prior years.

For some major business tax benefits, this is still one of the most significant. However, some changes to R&D taxes began in 2017. Through the Tax Cuts and Jobs Act, companies could no longer deduct R&D costs in the same taxable year.

Further, the new law now demands companies write down these expenditures over the next five years. Now manufacturers, in particular, look to Congress’s relief bills to see if R&D credits become restored.

How Did a Business Qualify for R&D Tax Deductions?

To qualify for R&D tax deductions prior to the 2017 law, a company had to develop new products and processes, enhance those products, or improve their prototypes. Manufacturers clearly fall under this category, making them one of the most important sectors to benefit from R&D tax deductions.

Now with the new tax laws, they may begin to hurt exponentially. Prior, manufacturers and all who qualified could prove various records to qualify for this tax credit.

It usually involved presenting payroll records, expense detail, notes on all projects being developed, plus any employee testimony. While this probably sounds a bit cumbersome, it was more than worth it.

Besides, many small businesses could also claim the credit against their Alternative Minimum Tax. As the economy falters, though, analysts wonder what the R&D tax reductions mean for manufacturers and small businesses.

The Hope for R&D Tax Relief in a Relief Bill

U.S. Congress is still going through the process of passing a relief bill to help businesses struggling through COVID-19 closures. Many business analysts contend that R&D tax relief in a relief bill is a must to help manufacturers survive in volatile times.

Congress clearly did not see COVID-19 coming when they enacted the 2017 tax law changes. Now the need to carefully document their expenditures over the next five years is sure to create some big problems for manufacturers in an age of economic uncertainty.

As Bloomberg Tax points out, competitiveness in manufacturing could become affected by 2022, leading to those same manufacturers going overseas to find relief. Over in Europe, R&D tax credits continue without any cuts, making it a more attractive place to base operations.

Still, Congress might fix the R&D tax issue here since one particular bill is on the table. The problem is convincing Congress to include it in the relief bill everyone hopes becomes a reality.

A Proposed R&D Tax Bill

A rare bipartisan bill is out there waiting for passage related to R&D tax relief. Back in 2019, Reps. John Larson (D-Conn.) and Ron Estes (R-Kan.) created a bill asking for the restoration of the original R&D tax law.

This bill seems to have become lost in the shuffle recently with various lobbyists pushing to include it in a future relief bill package. One major lobbying group is Intel. Sharon Heck, Intel’s CTO and Treasurer (and head of the R&D Coalition) is at the helm of getting this bill passed.

Last spring, Heck and the entire R&D Coalition sent a letter to Congressional leaders asking them to take action. Without some kind of passage soon, it could end up cutting 23,400 R&D jobs through 2022, leading to numerous ripple effects in the U.S. economy.

As with everything else, this is up in the air, though we continue to look in on it to update you with the latest tax information.

Contact us here at Incentax LLC to learn more about today’s most pressing tax issues.

R&D tax credits recession

How the R&D Tax Credit Can Help in a Recession

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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.

What Is the Research & Development Tax Credit?

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There are many valuable economic incentives offered by the government to help businesses reduce current and/or future tax liabilities.  One incentive program in particular, known as the Research and Development Tax Credit, rewards businesses for their investment in domestic research.  Those that qualify can then use the additional source of revenue to stay competitive, hire additional employees, and enhance day-to-day operations.

WHAT IS THE R&D TAX CREDIT PROGRAM?

The R&D Tax Credit was first introduced in 1981 as a way to encourage innovation throughout the economy, create and retain technical jobs and increase global competitiveness.  It is available to any business that develops new or improved products, processes or software systems. This means that businesses of all sizes and in a variety of industries can be eligible to claim this tax credit, not just major corporations with research labs.  Taking advantage of the R&D Tax Credit can help taxpayers alleviate some of the financial burden in trying to remain competitive in their respective industries.  

WHAT ACTIVITIES QUALIFY?

Companies that invest money, resources and time towards improving a product, technique, formula, process or software, or inventing of a new product or process, likely qualify. Below are common qualifying research and development activities:

  • Designing or developing new or improved products, processes, or formulas
  • Developing new or improved software technologies
  • Evaluating and testing new concepts or materials
  • Developing models or protypes
  • 3D or CAD modeling
  • Beta testing

HOW DOES THE R&D TAX CREDIT WORK?

The R&D Tax Credit can apply to any business that incurs expenses for performing qualified research activities. The following are the types of qualified research expenses that the credit is comprised of:

  • Wages paid to employees directly working on, supporting, or supervising the R&D process
  • Supplies consumed during the R&D process (ie, for prototyping and testing purposes)
  • Payments made to outside contractors hired by the taxpayer to assist in the development process

RECENT CHANGES TO THE R&D TAX CREDIT

Although billions of dollars worth of R&D tax credits have been claimed, many taxpayers still faced hurdles in being able to take advantage of the tax credit despite having qualifying activities and expenses.  This was mainly due to the fact that companies losing money could not monetize the credit, and that the credit could only offset regular tax liability.  When the PATH Act was signed in December 2015, the R&D tax credit was not only made permanent, but it also removed some of the barriers that many start-up companies faced to claim the tax credit. 

The PATH Act now allows eligible small businesses to use up to $250,000 of R&D credits annually against payroll tax liability. 

WORKING WITH INCENTAX

Staying competitive by developing new or improved products or software systems can be extremely expensive and time consuming for businesses.  Such innovations often fail, leaving companies with no return on their investment.  By claiming the R&D tax credit, businesses are able to alleviate some of the financial burden associated with such risky initiatives.

It is important to mention that maintaining documentation related to a taxpayer’s R&D activities can form the basis of a successful R&D credit claim.  Therefore, it is important to work with tax credit professionals like Incentax who can assist with the process.  

Contact us today to conduct R&D study for your business.