The Research & Development (R&D) Credit may be one of the most misunderstood and underused incentives in the federal tax code. There are a lot of myths about the credit that cause businesses to think that it doesn’t apply to them or that, if it does apply, the value is so limited that it doesn’t deliver a significant benefit. Here’s a look at a few of the misconceptions that have cost businesses millions in missed tax credits over the years.
- The R&D Credit only applies to businesses with acres of research facilities and dozens of white-coated employees who are doctors/scientists/engineers that spend all of their time on research. The credit certainly does apply to outfits like these, but that is only the tip of the iceberg. Any reasonable costs your trade or business incurs for activities intended to help eliminate uncertainty about the development or improvement of a product, including improvements to production processes or techniques, may qualify for the credit. And the employees involved do not have to be full-time researchers. Individuals with other responsibilities in your business can track their time and expenses related to research on process improvement and allocate those amounts to the credit calculation.
- The end result of the research must save mankind, end world hunger, bring everlasting world peace, or accomplish some other monumental leap forward for humankind. Whether expenditures qualify as R&D expenditures depends on the nature of the activity to which the expenditures relate. Neither the nature of the product (or improvement) being developed, nor the level of technological advancement matters when determining if the costs your business incurs qualify for the credit. Costs that you incur to improve a production process or reduce waste in your own business may qualify.
- The credit can’t help a business that operated at a loss for tax purposes in the current year. In fact, once an R&D credit has been earned, it can be carried forward and applied to future tax liabilities for up to 20 years.
- The R&D Credit only helps established, large businesses reduce their income taxes. Recent changes to the law have made the credit even more beneficial to startups and small businesses. Smaller, newer businesses that qualify can use the credit to offset payroll tax obligations and alternative minimum tax assessments. These provisions offer additional opportunities for startup and growing businesses to utilize more of the credit in the current year rather than carrying forward into the future.
- R&D Credits are only available for successful research—amounts spent on research that didn’t produce a usable result don’t qualify. This is a common misconception that is flat-out wrong. As noted above, the availability of the credit is based on the nature of the activity to which the expenditures relate. If your business invested money and/or time attempting to improve or eliminate uncertainty about a process or product, the expenses attributable to that effort qualify.
- A business loses deductions for R&D expenses if it chooses to take the R&D Credit. The law provides an option that allows businesses to take a limited R&D Credit and still deduct some R&D expenses from taxable income. As long as your business effectively identifies R&D expenditures throughout the year, it’s a relatively easy comparison at tax time to determine which scenario will provide you with maximum tax benefit.
- Some states offer R&D Credits as well. This last item doesn’t qualify as a myth so much as it does a “little-known truth.” The laws on this vary significantly from state to state, so don’t assume you’ll get an extra credit or deduction at the state level without doing some investigating first. But, when qualifying research is done in the right state, it can result in additional savings at tax time.
When it’s all said and done, the R&D Credit can provide significant tax savings to any business that creates products or faces constant pressure to keep up with technological advances to stay competitive. If you’re thinking that your business may be missing out on tax-saving opportunities related to R&D, we can help you quantify the potential benefits of claiming the credit.
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