Business owners in nearly every industry are aware of the existing federal and state research and development (R&D) tax credit programs aimed at rewarding companies for their day-to-day efforts toward producing new or improved products, systems, processes or software. The R&D tax credit is a government-sponsored benefit that provides cash incentives for companies conducting R&D in the United States. These economic incentives were implemented to stimulate research and development in industries of all sizes, but up until recently, their impact was muted due to the fact that they were temporary (subject to legislative renewal every few years).
Many business taxpayers have at one time or another tried to benefit from the R&D credit, only to find that either 1) their business was a flow-through entity, and since the ultimate shareholder was liable for alternative minimum tax (AMT), the R&D credit didn’t provide any actual benefit, or 2) when R&D was the most intensive (typically at the start of a company’s life) there was no tax liability, making the credit useless.
What Companies Are Eligible?
The R&D tax credit may seem targeted toward science and engineering businesses, but it actually applies to businesses of all types and sizes, not just major corporations with research labs. Any company that designs, develops or improves products, processes, techniques, formulas, inventions or software may be eligible. In fact, if a company has simply invested time, money and resources toward the advancement and improvement of its products and processes, it may qualify.
Most companies don’t have dedicated R&D laboratories. In fact, most are performing R&D in their test kitchens or fields, in their wineries or distilleries, or right on their production floors. Wherever experimentation occurs, R&D may be found.
There are a host of industries that can qualify for this tax credit based on activities that they are likely conducting just to remain relevant and competitive in their market. Examples include:
- Textile manufacturing
- Forest product processing
- Architectural and design activities
- Software development
- Environmental engineering
- Health and wellness services
- Financial payment processing
- Food and beverage manufacturing
- Water treatment
- Energy efficiency improvements
What Is the Value of the Credit?
The credit is computed based on a formula that takes into account research expenses in prior years. Typically, a company can expect to receive a credit that amounts to about 6–10% of their qualifying research expenditures, and possibly more, depending on how their expenditures fluctuate from year to year. Additionally, the R&D tax credit regulations allow eligible taxpayers to “look back” to all open tax years (typically three years plus the current year) for potential research credits that were never claimed.
What’s New with the R&D Credit?
The recently enacted Protecting Americans from Tax Hikes Act of 2015 (2015 PATH Act) contains a provision making the R&D tax credit permanent. The estimated tab for this expansion is $113 billion over the next 10 years. The government’s hope is that this change — making the credit permanent and reducing the restrictions on who may benefit from it — will encourage businesses to invest more in R&D than they otherwise would have planned. The credit had lapsed for expenditures in 2015, but the legislation is also effective for those expenditures.
Importantly, the new law makes two major changes to the credit, both favorable to small businesses. First, it provides that, beginning in 2016, the credit may be applied against a taxpayer’s AMT liability. Also, beginning in 2016, the new law provides that the credit can be used by businesses in beginning stages against the employer’s portion of the Social Security portion of the employer’s payroll tax (i.e., FICA) liability. These expansions make the credit available to many small-business owners who previously would not have been able to realize the benefits.
If your business ever changes or improves its processes, explores new products for customers, develops new solutions for its clients’ problems, or is interested in paying less in taxes, the potential R&D tax credit is worth discussing further.