TAXING MATTERS
T . MARK RUSH , CPA
Partner Ham , Langston & Brezina , LLP
PART 2
R & D tax credits : A valuable cash infusion for businesses
It is important that the taxpayer be able to
substantiate the amount of its R & D expenditures . To assist its personnel in conducting auditing credit claims , the IRS has issued an audit techniques guide that focuses on research expenditure substantiation issues .
Is a business more likely to be audited if it takes the R & D credit ? Our firm has not seen any evidence that claiming the credit increases a company ’ s audit risk — if the credit claim is filed correctly and substantiated . However , companies claiming the R & D tax credit must be well documented to withstand an audit . Thus , many CPA firms ’ partner with independent R & D professional service firms that have the expertise to navigate and document proper record keeping and testing of activities , and to capture all the qualified expenditures to maximize the benefit .
The IRS will look at the overall size of the credit claimed in relation to the taxpayer ’ s industry averages . Since companies often amend their returns to claim the credits for prior open years , the amended returns often get an additional look by the IRS .
Bottom line : Taxpayers should not attempt to claim the credit without professional help . They should be sure to hire an experienced tax adviser and hire experienced and qualified specialists to help them evaluate , prepare , and defend their R & D tax credit claim .
The R & D credit is not only for pharma , biotech , and technology companies
Even if a company doesn ’ t employ scientists in white lab coats , it may be able to take the R & D credit . Some of the industries frequently overlooked for this credit include architecture firms , engineering design firms , and software development companies . Startup companies that do not have an income tax liability yet ( i . e ., they ’ re not generating taxable profits ) can also take the R & D credit against a portion of their employer payroll taxes .
A small or large business may be eligible for the credit if it engages in activities such as these :
It develops or designs new products or processes , It improves existing products or processes or It develops
or improves upon existing prototypes and software .
In 2003 , the “ discovery rule ” was removed . That was a big milestone because it meant that a company ’ s research activities no longer had to be “ new to the world ” . The activities only had to be “ new to the taxpayer ” to qualify for the R & D credit — a standard that is much more favorable to companies .
In 2015 , the PATH Act made the R & D tax credit permanent — which motivated many more companies to include the credit in their long-term tax planning strategies . Also , the PATH Act modified the credit for the benefit of small and midsize businesses , including startup companies . Startups and small businesses may qualify for up to $ 1.25 million ( or $ 250,000 each year for up to five years ) of the federal R & D tax credit to offset the Federal Insurance Contributions Act ( FICA ) portion of their annual payroll taxes ( Sec . 41 ( h )). Don ’ t confuse innovation with ‘ new and improved ’ “ New and improved ” refers to how new products or new features of an existing product are defined . True innovation generally includes the improved product , but also the process and a solution that may even include the impact on people of the product , process , or solution .
The following is a checklist that can used to determine the possibility of claiming an R & D tax credit , check all criteria below that apply :
• Are you currently , or have you in previous tax years , created or made improvements to any existing products , processes , or technology ?
• Is your company in the planning stages for a new or improved product or process ?
• Do you foresee current or upcoming tax liabilities ?
• Did you have tax liability last year ?
• Have you recently received or applied for a patent ?
• Have you developed unique internal use software ?
• Have you used third-party consultants to create or test new products or processes ? If you have checked off one or more of the criteria above , then you may qualify for the R & D tax credit for past , current , or future years . Don ’ t leave this valuable tax savings opportunity on the table .
18 MOMENTUM