Clayton & McKervey, a certified public accounting and business advisory firm helping closely held businesses compete in the global marketplace, recommends that businesses reconsider the Research & Experimentation (R&E) tax credit as a tool to strategically improve their bottom line. The benefit, also known as the R&D tax credit, is available for the development or improvement of products, processes, techniques, formulas, inventions or software, but many companies are not claiming this credit or utilizing it to the fullest extent, according to Sarah Russell, CPA, a Clayton & McKervey shareholder and the point person for Research & Experimentation tax strategies at the firm.
“Studies have found that less than 10 percent of U.S. companies are taking advantage of this tax incentive,” Russell said. “There are many misconceptions surrounding the R&E credit from what expenditures qualify to current tax law to how much benefit will be awarded. Companies that devote time to properly documenting their activity through an R&E study can expect their credit to be about 6.0–6.5 percent of qualified research expenditures—which can add up to a $275,000 savings in tax dollars for a C corporation with $1 million in taxable income, for example.”
Russell also notes that because the R&E tax credit is a dollar-for-dollar credit against the taxpayer’s federal income tax liability, companies may get a twofold benefit—the deduction in the year the expenditure is paid, as well as by claiming the tax credit.
Russell clarifies the six most common misconceptions about the R&E tax credit:
1.) The Tax Cuts & Jobs Act (TCJA) of 2017 will negatively impact the R&E tax credit.
Fact: TCJA further expanded the utilization of the credit by eliminating AMT for C corporations. Staring in 2018, large corporations (gross receipts over $50 million) no longer are subject to the alternative minimum tax (AMT) limitation which previously impacted the R&E.
2.) The R&E tax credit is not permanent and will eventually go away.
Fact: The passage of the Protecting Americans from Tax Hikes Act of 2015 (PATH Act) made the R&E permanent—granting greater flexibility to companies so they can better plan and prepare for an R&E study. PATH also allows eligible small businesses to offset regular and AMT liabilities and certain start-ups to offset the employer’s portion of FICA payroll tax liabilities.
3.) Inventions have to be groundbreaking or patentable to be considered for an R&E tax credit.
Fact: Activity does not have to be breakthrough; it can be evolutionary in nature, such as improvements to existing products or processes as long as they’re made to eliminate uncertainty.
4.) If the project does not move forward, it does not qualify for an R&E credit.
Fact: Failure is an option in this case; proof of failed activity supports the R&E credit claim because there is documentation of intent to remove uncertainty.
5.) The company is not showing a profit so it won’t benefit from an R&E credit.
Fact: While it’s true that the company must be profitable to utilize the credit, a business still should look into the R&E even if it’s not reporting a profit. Why? If the business is structured as an S corporation or a limited liability corporation (LLC), wages of active owners can be included. Also, the credit can be carried forward 20 years and back one year, so prior returns can be amended to reflect qualifying activity in profitable years and companies can plan ahead a year before projecting profitability.
6.) The company already deducts expenses related to R&E so it’s covered.
Fact: While the company may be getting a deduction, the actual tax credit will be worth more than only R&E deductions alone. Federal regulations allow for companies to receive the twofold benefit of both the deduction and the credit.
Russell says some of the best candidates for the R&E tax credit are companies that have business related to technology, industrial production and design, and also some machine shops, tool and die shops, and custom machine manufacturers.
“Anyone in the business of improving industrial production processes through controls, automation or system integration should definitely consider the R&E tax credit,” Russell said. “It’s worth a second look to make sure the business is receiving all the money it can.”