Necessity may be the mother of invention, but American business is definitely its father. The U.S. economy depends on innovative businesses to create jobs and power GDP. If your company is one of these innovative businesses, make sure you know about the Research & Development (R&D) Tax Credit. Don’t leave money on the table that could be going back in your pocket.
What is the R&D Tax Credit?:
The U.S. government created the R&D Tax Credit in 1981 to encourage innovation. The credit provides a dollar-for-dollar offset of income taxes, based on the amount of a company’s qualified research expenditures. The federal R&D Tax Credit typically saves companies up to seven percent on their income taxes. In addition to the federal credit, many states have R&D Credits of their own that mirror the federal credit’s requirements and provide even more tax benefits.
What changed and how do you benefit?
In December 2015, President Obama signed the Protecting Americans from Tax Hikes (PATH) Act. Among its numerous provisions, the PATH Act made three major changes to the R&D Tax Credit:
- The R&D Tax Credit is now permanent. Prior to the PATH Act, the R&D Tax Credit had been renewed 15 different times and had expired as of Dec. 31, 2014. For the 34 years of the credit’s existence, it was never guaranteed whether companies would be able to continue taking the credit or whether the benefit would end. Now that question has been answered – the R&D Tax Credit will remain on the books.
- Benefit to you: The impermanent nature of the R&D Tax Credit up to this point prevented companies taking the credit from budgeting and forecasting accurately. With the question of permanence finally settled, companies will be better able to plan for their financial future and utilize the credit to accelerate growth.
- Congress has eliminated the Alternative Minimum Tax restriction for small businesses. Alternative Minimum Tax (AMT) is the government’s way of making sure everybody pays a certain amount of tax, even companies with a lot of deductions. In essence, taxpayers calculate both their regular income tax and AMT amounts; if regular income taxes are lower than AMT, the taxpayer pays AMT instead. Prior to this change, the R&D Tax Credit could not be taken against AMT. Now companies and individuals paying AMT will be able to use the credit for tax years starting on or after Jan. 1, 2016 if the company has less than $50 million in average sales over the prior three years.
- Benefit to you: The R&D Tax Credit is intended to help small businesses, but many small businesses are S-corporations and LLCs – which are frequently impacted by AMT. Because of the AMT restrictions, those businesses have not been able to use the credit in the past. Now, small business owners will be able to finally use the credit to re-invest into their business’ growth.
- Certain startup companies can use the R&D Tax Credit against federal payroll withholding. Many young and growing companies don’t yet have any income, and thus don’t pay any income tax – preventing those companies from receiving any benefit from the credit. The PATH Act changes allow companies that are fewer than five years old and have less than $5 million in gross receipts in the current year to use their credit to offset up to $250,000 of payroll taxes annually for tax years starting on or after Jan. 1, 2016.
- Benefit to you: Startup companies are the biggest creators of jobs and producers of innovation, the two main goals of the credit, yet these companies often have no income while they develop their products. Startups were thus previously unable to utilize their R&D Tax Credits. Startups can now apply the R&D Tax Credit against their federal payroll taxes, providing an immediate benefit that helps these companies continue to innovate and grow.
To qualify for R&D Tax Credits, your company must be developing or improving a product or process. Your work should involve the hard sciences (e.g., engineering, computer science, biology, etc.). There must also be some uncertainty around whether a product will work or how it will work, and an iterative process of experimentation should be followed to work through that uncertainty. Additionally, at least some of the R&D work must be done here in the United States.
What do you do next?:
If the description above sounds like your company, the money you spend on wages for employees or contractors doing the research and the supplies used during the process can be used to calculate your credit. Tools such as the CEO Tools R&D Tax Credit Assessment can help you determine how much you could save. (The CEO Tools R&D Tax Credit Assessment is free for ATDC members – just use code ATDC16 at checkout.)
You can also contact a tax preparer who specializes in securing and substantiating R&D
Tax Credits. HA&W has a dedicated, in-house R&D Tax Credit team, the largest practice headquartered in Georgia, which specializes in procuring R&D Tax Credits for clients. For the 2014 tax year, we helped our clients save more $21 million.
For more information, please contact me at firstname.lastname@example.org or at 770.353.2772.
Ms. McDonald is director of Research and Development Tax Credit Services at Habif, Arogeti & Wynne, an ATDC sponsor company.