This post is part of Acuity’s Master Class Series, dedicated to shedding light on financial and other influential industry topics. Our goal is to provide a deeper understanding to the business community to empower their strategic decisions. We sat down with Betsi Barrett, Credits and Incentives Partner at Bennett Thrasher, to discuss Research and Development Tax Credit.
When in the trenches of business ownership, it is nearly impossible to keep up with the latest changes to the tax code. In this post, we take a deep dive into the complex Research and Development Tax Credit (R&D Tax Credit) and how a business can potentially take advantage of this beneficial tax break.
What is the Research and Development Tax Credit?
The Research and Development (R&D) Tax Credit is a federal (and state) tax credit under the Internal Revenue Code section 41 to incentivize companies to perform research and development activities within the United States. The credit has expired and been extended several times since first introduced in the Economic Recovery Tax Act of 1981.
The latest 2016 extension made the credit permanent, allowing the United States to become more internationally competitive with research and development opportunities. The goal? To encourage domestic innovation and stimulate economic growth domestically
What exactly qualifies as research and development?
Listed are the four main questions to help determine whether or not an endeavor could qualify for the R&D Tax Credit. Its more inclusive than most would assume.
- Are you developing a new or improved product or process that relates to production, performance, reliability, quality or cost reduction?
- Are the activities technological in nature?
- Is there technical uncertainty?
- Are you undergoing a process of experimentation, evaluating alternatives to solve your uncertainties?
Lightning round questions with Betsi:
Q: Why is the R&D Tax Credit so important to businesses?
A lot of companies don’t know about this credit. And even if they do know, they don’t think they can qualify. People assume that R&D implies cutting-edge innovation and white lab coats, but that’s not the case from the tax perspective. The definition is so broad. It’s a great time to update your understanding about business R&D efforts and realize the potential tax credits your business could leverage. If you’re spending money to develop new products or processes, you should look into taking advantage of this credit opportunity.
Q: How is the credit calculated?
There are two separate calculations on a federal level. Most states have their own calculation methodology. Regardless of calculation, all states consistently follow the federal R&D qualification guidelines. The Federal credit can roughly be estimated at 6.5% of qualified research expenses. In Georgia, it can be up to to 10%; another example of Georgia being a tax-friendly state.
Q: What are the main caveats and challenges your clients run into when trying to qualify?
Thinking they can do it on their own. We notice that when a client has tried to prepare everything on their own, they’re typically doing so from a calculation perspective. This opens them up to a larger IRS audit risk because they’re not putting substantiation around the credit they are claiming. That really is the key to it all and companies typically struggle with that internally. We also see companies attempting to do their own calculations, which we don’t advise. This is a situation where utilizing a subject matter expert will allow the best possibility to maximize the credit’s potential. It can also become a challenge around substantiating the credit because there is no real standardization or outline for potentially qualifying businesses to follow. We have guidance on what the IRS wants to see, but there’s no specific requirements. That’s why it’s so beneficial to leverage an expert – they know what documentation is needed, understand how things should be set up and experience to help companies take full advantage of the credit.
Q: What’s the typical reason why companies don’t qualify?
Using contractors who aren’t located in the United States is a big one . R&D must be US-based to qualify for the tax credit . We also sometimes see companies who have received some type of government grant to do the research and development who do not qualify for the credit.
Q: What are the benefits of this tax credit becoming permanent?
In late 2015, the PATH Act (providing over $620 billion in tax reductions for families and businesses) was passed by the House of Representatives. This is what made the R&D Tax Credit permanent. It also gave two additional benefits to help smaller companies thrive. First, startups that have less than $5 million in gross receipt and are in their first five years of business can now use the federal credit to offset federal payroll tax withholding. Second, companies that have average gross receipt of $50 million or less over the past 3 years can now use the R&D tax credit to offset the alternative minimum tax (AMT).
Q: What is the takeaway – next steps?
The R&D Tax Credit can be incredibly impactful for a business. This credit can enable companies to take on additional headcount or provide capital back to the business. More companies qualify than they would think. It’s worth initiating a conversation with an expert to see if this is an option.
Need help navigating the IRC, small business tax prep or finances? Contact Acuity’s Director of Development and Partnership. We’ll help you navigate through financial hurdles while connecting you with our trusted partners like Betsi at Bennett Thrasher.