Many companies that create software or tangible products are eligible for a research and development (R&D) tax credit—a dollar-for-dollar credit equal to a portion of their annual qualified research expenditures (QRE)—but they often underestimate their benefit. Some rely on internal or external accounting to quantify how much money they can save, although a closer look at their QRE often yields more categories that qualify for cost savings than they might expect. QRE can be defined as any eligible expense incurred in creating products to be used outside your own firm including wages, supplies and contract research expenditures. For most companies, full-time product development engineers’ wages are the first thing that comes to mind and may be the easiest to recognize; however, a closer look at definitions and examples may lead to the inclusion of additional wages, supplies or contract research costs, which can increase the amount of the tax credit and result in a significant increase to their bottom line.
Tasks That May Qualify for R&D Tax Credit
Some tasks that can be performed within an organization that can qualify for the research and development tax credit but may go unnoticed are:
- Software development or improvement
- Automating /streamlining internal processes
- Integration of new machinery (CNC, SLA, SLE, etc.) into an existing process
- Testing/quality assurance: ISA 900X, UL, Six Sigma, etc.
- New product and process development
- Developing new concepts or technologies
- Developing tools, molds, dies
- Developing or applying for patents
- Design (layout, schematics, autoCAD)
- Prototyping or modeling
Not Just for Manufacturing Companies
The R&D tax credit was not designed exclusively for manufacturers, although they often qualify. Qualification is based on activities performed by the company and can exist across many different industries. In fact, companies in the architectural, engineering, software and construction industries often qualify at much higher rates than traditional manufacturers. (For related reading, see: What Are the Benefits of Research and Development for a Company?)
No Need to Be Profitable to Apply
In December 2015, the Protecting Americans from Tax Hikes (PATH) Act was signed into law. It makes billions of dollars of federal tax incentives and cost reduction programs available to startup companies, regardless of whether they are profitable. The definition of a startup under the PATH Act is simply any company formed after 2010, with gross receipts for five years or less and with gross receipts less than $5 million in 2016 and each subsequent year the credit is claimed. Qualifying businesses may capture up to $250,000 of incentives and tax credits annually and be able to claim credits against payroll (employer FICA) taxes if they don't owe income tax. Companies that don't meet this start-up criteria still qualify for federal tax credits toward income tax under the PATH Act with the newly expanded R&D tax credit definitions. A small business qualifying under The PATH Act with a payroll of $250,000 would normally incur approximately $15,500 in FICA payroll tax. An estimated R&D tax credit of similar size would offset their tax liability 100%, putting those funds back into the owner's hands to further grow their enterprise.
Even companies who currently receive an R&D tax credit may not be getting all they are entitled to. Hiring an R&D specialist to interview managers and quantify qualified research expenditures in detail can pay significant dividends by uncovering QREs allowed by the IRS but not currently being accounted for by your tax professional. Many companies with eligible R&D expenses can receive tax credits for up to three years of prior filed tax returns, often resulting in an immediate, one-time cash infusion for the firm in the form of prior tax refunds. Additionally, current year QREs can allow companies to reduce estimated tax payments, thus increasing current positive cash flow without waiting to file the next return with the IRS. When considering who to hire to perform an audit of your qualified research expenditures look for these things:
- Knowledge of less common but still relevant QRE categories
- Significant experience in volume of cases prepared
- Willingness to perform on contingency with fees capped at a percentage of savings generated
- An IRS audit protection guarantee
- A team that can conduct interviews with personnel to properly identify all QRE activities
(For related reading, see: R&D Spending and Profitability: What's the Link?)