With the 2016 tax filing deadline passed and many businesses on extension, there’s still time to take advantage of the Research Tax Credit (R&D tax credit). The R&D tax credit is available for taxpayers that make investments in developing or improving their products.
The R&D credits have traditionally been appealing to manufacturers, however we are seeing more and more industries qualifying for R&D credits. These businesses are developing or improving the functionality and performance of a “business component” – a product, process, computer software, technique, invention or formula. Essentially, these credits are encouraging businesses to research and test alternative, possibly more efficient, ways to produce the products or services they provide. Following recently issued government guidelines, there must be a process of experimentation with the purpose of the R&D project being to eliminate uncertainty about a company’s capability or method for developing or improving the business component. In other words, the project must be intended to spur innovation with some calculated risk that it may not work.
While the R&D tax credits generated prior to January 1, 2016, are still only allowed against regular tax, the IRS made changes last year to allow eligible small businesses who have a 3-year average annual gross receipts of $50,000,000 or less to offset the AMT tax with their credit.
The expansion of this credit makes it more favorable for businesses who want to increase cash flow and minimize tax liability. This has allowed small business to use R&D Credits at a much more prolific rate than in the past.
While the R&D tax credit goes back to 1981, Congress initially approved it on a temporary basis and extended it 15 times before permanently putting it in the books last year. This permanency can now encourage businesses to do more long-term planning and motivate them to track expenses knowing that it won’t go away before they are ready to use it.
In addition, companies with gross receipts of less than $5 million for the year and no gross receipts for the previous five years may apply the R&D tax credit against payroll taxes up to $250,000.
Although meeting the IRS’ new four-part test requires a lot of documentation and can be cumbersome, TBC can help. We have worked with clients to analyze the time and costs of doing a study, the value of the credit, and the risks of potential audits.