Tax credits are important. These are our government’s “carrots” for business owners. They are saying “Hey! Please focus here! Our economy depends on it! And if you do, we’ll thank you with a reduced tax bill.” Credits are dollar-for-dollar reductions in your tax bill. 100,000 in credits = $100,000 off your taxes (unlike a deduction for which the actual benefit is really the deduction times your tax rate (i.e. a 100,000 deduction = $35,000 in tax savings at a 35% tax rate). But enough numbers, the bottom line is that our government knows that research and development is a key factor to economic growth. It keeps us ahead of our competition. That’s why it’s no surprise they reinstated the R&D credit last year. And, unlike in years past where they only reinstated the credit for one year, this time they made it permanent. So now that we know it’s going to be around for a while, below are 10 key things that you need to know.
- Yes, technology companies are eligible for this credit. And the technology or software you develop does not have to be groundbreaking. Chances are if you are working to develop a new version of an existing technology or software application, in any industry, there is a strong chance you could benefit from the Research and Development tax credit. With respect to software, even software developed for internal use may qualify.
- Do you need an outside R&D firm? Well, it depends. Your tax preparer, given the necessary information, can complete the tax form. However, failure by taxpayers to record and maintain documentation supporting the qualified research activity, as required by the IRS, is a major reason for the loss of a research credit. In addition to guiding you with recordkeeping, an R&D firm may also help you identify R&D qualified activity that you might not have considered and will help you support your positions under audit. All of these services do come at a cost though – finding the balance between risk and reward is key to this decision.
- Did you know that if you are a qualified small business you may be eligible to offset payroll taxes with R&D credits generated? What a great opportunity for those startup tech. companies who may not have started generating profit and income taxes yet!
- Does claiming the research credit increase my chances of an IRS examination? No one can say for certain. The research credit, if entitled, can provide some HUGE tax savings and therefore it is reasonable to conclude that the IRS scrutinizes tax returns claiming the credit more than returns without it. The key here is to know the risks and make sure you are comfortable with, and able to support, the positions you are taking with respect to this credit.
- Can I use R&D credits even if I’m in AMT (Alternative Minimum Tax)? You can now! In the past you couldn’t offset AMT but that all changed with the last extension (with certain exceptions (of course!)).
- Your state may offer R&D credits – MA, RI & CT do and they all have their own ways of calculating them (nothing your CPA can’t handle!).
- Federal R&D credits carry forward for up to 20 years if you don’t use them! Most states with R&D have carry- forward provisions as well, however, they are often for much shorter periods. Also, refer to # 3 above and see if you can use them against payroll taxes instead.
- Think you missed out on these credits in the past? You can amend to take advantage of this credit (generally up to three years back) however the way you calculate the credit is more limited on an amended return.
- Federal R&D credits are available to most businesses regardless of the structure of your entity. If you operate a flow through an entity that doesn’t pay taxes at the corporate level, those credits can pass down to you to be claimed on your individual return. This feature may or may not be available at the state level depending on the state.
- While a full discussion of qualifying activities is outside of the scope of this post, it is helpful to know that the calculation considers wages, supplies and contracted R&D costs (limited to 65%). It most notably excludes the cost of any equipment used for R&D activity (including depreciation) and any overhead costs. Also, any research after commercial production commences does not qualify.
For More Information
Below is a link to some additional information on what activities qualify. This is basic information that can be found right on the IRS’s website. Check it out and more importantly call your CPA who, as your trusted advisor, will help you see how this opportunity might fit into your 2017 tax plan.