Your Accounting Should Be Utilizing R&D Tax Credits
The Dollar for Dollar Benefit of Tax Credits
With the startup market booming and large sums being spent on research and development (R&D), many newly profitable companies forget to look forward to the days of when they move from the red into the black. Or when they become profitable, they forget to update their processes for their changing tax position. Their accountants, after either not asking or not understanding the business, file their taxes treating their R&D as just another expense. While those early losses eventually get treated as Net Operating Losses, they are not the most tax efficient method to use.
Research and Development tax credits, which were created to encourage investing, help increase a company’s ROI and minimize the cost of investing in the future. The credits reduce your tax bill on a dollar-for-dollar benefit. Operating expenses, or Net Operating Losses if they are being carried forward, instead reduce your taxable income. Thus the latter only saves your company 35% (the corporate tax rate) of those expenses, while the dollar-for-dollar impact is 3x larger.
Here’s a list of expenses that qualify for the Research & Development Credit:
- In-house Research:
- Wages including bonuses and nonqualified stock options
- The amount spent on the right to use computers to conduct qualified research
- Contract Research:
- Services engaged in qualified research
- Direct supervision
- Direct support
- Activities that are directly related to product development and improvement:
- Brainstorming of ideas
- Analyzing the idea and concepts surrounding the product
- Creating a tangible product out of the idea
- Creating a prototype of the product
- Developing the product and analyzing if the product has business value and a business sense
Not all R&D and not all industries are created equal, so unfortunately a number of companies will not be able to leverage the credits. Here is the four-part test to see if your company qualifies for the credit.
Four Part Test to Qualify for the Research & Development Credit:
- Permitted Purpose:
- Does the product improve in functionality, performance quality, and reliability?
- Technological in Nature:
- Does the activity performed primarily rely on engineering and/or the sciences?
- Elimination of Uncertainty:
- Are you certain the changes made or improvements improve the functionality, performance quality, and reliability, versus just aesthetics or design?
- Process of experimentation:
- Have you evaluated all of your choices? Have you used the scientific method of trial and error to come to your results and determine a conclusion about your findings
If you believe your company qualifies for the Research & Development credit, have a conversation with your tax advisor or contact me @ email@example.com.
For additional reading on this topic, see the IRS’s own explanation of Research & Development tax credits and tips they provide.