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R&D Tax Credits (an underutilized small business benefit)

If research and innovation are part of your business’ culture, you should consider securing R&D Credits.

On January 2, President Obama signed into law legislation to make the “research and experimentation tax credit” (the “R&D Credit”) retroactive for 2012 and effective for all of 2013.  A noble effort, but the irony is many qualified small businesses aren’t availing themselves of it.  Manufacturers, contractors, architects, engineers, software developers and other innovators are leaving millions, perhaps more than a billion, dollars on the table annually.  Similarly, use of the “research and development” deduction has been avoided due to its status as a tax preference under the alternative minimum tax, subject to elections beyond the scope of this piece.

Even with this underutilization, $9 billion in R&D Credits were claimed in a recent year.  Did your business participate?

In recent years, agricultural companies claimed more than $5 million, real estate companies claimed more than $7 million, management companies claimed more than $60 million, wholesale and retail companies claimed $430 million, and transportation equipment manufacturers claimed more than $1 billion.

Unfortunately, as a Bloomberg Government study concludes, large companies claim a disproportionate share R&D Credits because many small businesses either find it too difficult to file the IRS required information or are unaware they qualify for R&D Credits.

According to Bloomberg’s study, small businesses account for 40 percent of private-industry research but received only 23 percent of R&D Credits in recent years. Bloomberg’s study found a few common reasons for businesses not taking full advantage of R&D Credits:

  • They do not know they qualify for a R&D Credit.
  • The R&D Credit formula is too complex and the required documentation is too difficult to obtain.
  • They are worried about making a long-term R&D investment when the R&D Credit could expire.

Tax credits usually mean more to profitable companies, but as R&D Credits can be claimed for all open tax years (generally meaning the current year and the past three tax years) and those credits carry forward for up to 20 years, R&D Credits are valuable even to companies currently operating at a loss.

Defining ‘R & D’

Time, money and other resources devoted to improving a product or process could result in a R&D Credit for your business.  If you devoted resources directed at:

  • Research which is technological in nature.
  • The activity and your devoted resources are directed at a new or improved product or process.
  • The activity and your devoted resources are directed at the discovery of information that is currently unknown.
  • The activity and your devoted resources must evaluate alternatives.

Hence, developing a lighter or more flexible tool, designing a unique electrical system for a new building, testing new materials, applying for a patent or streamlining an internal process can deliver an R&D Credit to your business.

R&D Credits cover employee wages directly contributing to R&D, supplies and software used in R&D activity, and contracted R&D services. There are two alternative measures of the R&D Credits:

  • 20 percent of R&D expenses above a “base amount” (based on a fixed base percentage and the company’s average annual gross receipts of the preceding 4 taxable year), or
  • 14 percent of R&D expenses above 50% of the company’s average R&D expenditures over its previous three years (aka the simple measurement).

Frequently, small businesses find it challenging to segregate normal business expenses from those that result in R&D Credits.  R&D specialists can assist in that segregation process and often return R&D Credits far in excess of the specialist’s fees.

Proposed simplification to R& D Credits

The Obama Administration has proposed two revisions that (a) raises the simple R&D Credit measurement to 17 percent and (b) makes the R&D Credit permanent.

Regardless of the Obama Administration initiatives success, there are short-term savings and long-term implications making current pursuit of R&D Credits a worthwhile exercise for forward looking companies.

To learn more about R&D Credits and how they may favorably impact your business, contact Stephen C. Smith, or your Holbrook & Manter representative before attempting to take full advantage of R&D Credits.  We facilitate R&D Credits for growth-minded clients.