There are thousands of eligible companies not taking advantage of the Research and Development (R&D) tax credit at the federal and state level. In our experience, if a company is not claiming the credit, it is due to one (or all) of the reasons listed below.
- The company thought it must be developing something new to the world to take advantage of the credit.
- The company thought it could not claim the credit if it was being paid for the work.
- The company thought it had to be profitable to use the R&D credit.
- My CPA does my taxes and he or she would include it if I qualified.
These misconceptions are incredibly common and we address each in greater detail below.
1: The company must be developing something new to the world to take advantage of the R&D Tax Credit.
Not true. The R&D Credit is open to virtually all industries. Employees do not need to be wearing lab coats and white gloves to qualify. If the company is developing or designing something new or improved and is going through a systematic trial and error process as part of the design or development, the company likely qualifies.
2: The company can’t claim the credit if it is being paid for the work.
It depends. “Funding” is an exclusion in the Internal Revenue Code, but not in the way that most people think. The guidance from the IRS requires a taxpayer to evaluate the “economic risk” of the project, not simply whether the company is being paid for the effort. Most of the companies claiming the R&D credit are being paid for the work, but it was determined that it bore the “economic risk.” This requires an analysis of the contract to determine the party bearing the economic risk.
3: The company must be profitable to use the R&D credit.
FALSE! In 2015, the PATH Act expanded the R&D Credit to small businesses. Now, new businesses can use the R&D credit to offset portions of their payroll tax. This is incredibly advantageous for startups who have payroll expenses but are still operating at a loss.
4: The company assumes its CPA would include it if the company qualified.
As CPAs, clients oftentimes expect you to know about everything covered within the Internal Revenue Code. Unfortunately, that’s an unrealistic expectation. With the ever-changing tax code, regulations, and case law, it’s impossible for CPAs to stay on top of everything having to do with taxes.
We’re here to help! From our conversations with our CPA partners, we’ve found that the most helpful information is sharing the top industries that qualify and what activities and expenses qualify.