Don Warrant, CPA
Director | Tax Practice
The R&D tax credit can deliver significant tax savings, but many small businesses don’t realize it’s available to them.
Yes, there is a tax credit available to all businesses, including small businesses, for R&D costs. The tax credit has been a part of the tax code in some form since the 1980’s, although for the vast majority of that time it was considered “temporary.” It had to be extended 16 times before being made permanent in the Protecting Americans from Tax Hikes (PATH) Act of 2015. Perhaps the on-again/off-again uncertainty of the tax credit’s availability has led to its underutilization by many of the businesses it was designed to help.
Whatever the cause, so many eligible taxpayers are failing to claim the available small business R&D tax credit that some members of Congress have introduced legislation aimed at improving government efforts to educate small businesses on the topic. There are two bills currently in the Senate and House, S. 650 and H.R. 1543 that would require the IRS and the Small Business Administration to work in partnership to develop basic training sessions and related information relating to federal income tax credits, especially R&D tax credits that benefit small businesses and start-up companies.
Those efforts should focus on 3 main problems:
- Small businesses don’t know the R&D tax credit exists. In the early stages of a business, tax planning sometimes takes a back seat to tax preparation. Owners who prepare their own tax returns or rely on tax preparers with limited experience may fall into the trap of “doing it like last year” instead of analyzing each year’s income and expenses with a clean slate. A failure to recognize the availability of the R&D tax credit in one year can be compounded by repeating the mistake in future years.
- Small businesses don’t think they have R&D expenses. Many taxpayers skim past the R&D tax credit because they assume it’s only available to companies “in the business” of research and development, like a pharmaceutical or technology corporation. In fact, the tax credit is based on the activity performed, not the industry of the taxpayer. Costs may qualify for the tax credit if the activity:
- --Is designed to eliminate a technical uncertainty,
- --Includes some process of experimentation,
- --Is technological in nature, and
- --Is intended to create a new or improved product or process.
Activities focused on improving or redesigning existing products, as well as designing new products, can qualify. Costs associated with creating or improving a manufacturing process or new software may be eligible. Recent IRS guidance even eased limitations on eligibility of R&D expenses related to the development of internal use software.
- Small businesses don’t have an income tax liability against which to claim the tax credit. Until recently, this hurdle used to make many startups and small businesses ineligible for the tax credit at a time when they most needed support. As part of the PATH Act, Congress enacted provisions allowing certain qualifying startups and new small businesses to claim the tax credit against the employer’s share of Social Security taxes and to calculate the tax credit without regard to alternative minimum tax limitations.
Now that the R&D tax credit is a permanent part of the tax code and its applicability to small businesses has been expanded, many businesses are taking the time to learn more about the tax credit and find out if they qualify. The calculation of tax credits and the election to claim them can be a complicated process. If you’re wondering whether your business (small or large) may be missing out on these R&D tax credit savings, please contact us at Freed Maxick.
Freed Maxick CPAs, P.C. is Western and Upstate New York’s largest public accounting firm and a Top 100 firm in the United States. Freed Maxick’s reputation and experience with business and tax issues has made us a go-to firm for businesses and individuals from all over the U.S. and Canada and around the world.