The R&D Tax Credit – Does Your Business Qualify?
Businesses never want to leave money on the table. But when it comes to the R&D Tax Credit, some unknowingly do just that. These oversights often stem from confusion about the rules that govern the R&D Tax Credit or a belief that the credit is not applicable to one’s operating activities for one reason or another.
Here, we take a look at how to determine eligibility for the R&D tax credit, examples of companies that navigated the process, and what’s required for businesses to claim the R&D Tax Credit.
Determining R&D Tax Credit Eligibility
Since its introduction in 1981, the legislation surrounding the R&D Tax Credit and who is eligible for it has changed substantially. Today, many company owners and executives still carry a belief that qualifying for the R&D Tax Credit requires that their business must operate within a science- or research-oriented space. However, legislative updates passed in the past decade have broadened eligibility to include companies that have applied R&D principles to improve their products, services, or operations. Specifically, a four-part test is used to determine whether a company is eligible for the R&D Tax Credit:
- Eligible Purposes
As noted above, the R&D work must be associated with creating new or improving existing elements of the business, whether that be the product, logistical components, or service quality. The element doesn’t have to be new to the industry – just new to the business.
- Technological in Nature
The R&D activity in question must be rooted in the hard sciences, namely physics, chemistry, engineering, computer science, etc. There is no requirement, however, to carve out new ground in these disciplines.
- Elimination of Uncertainty
The intention of the R&D activity must be to eliminate uncertainty regarding the business component’s creation or improvement. This involves establishing the capability or method applied in the activity.
- Process of Experimentation
Via simulation, trial and error, modeling, or other methods, the company must demonstrate that it has assessed alternatives for arriving at its outcome. This could include trials, user testing, or a range of other activities.
Owners and others that find themselves confused about any elements of the test can easily confer with an external finance expert steeped in R&D Tax Credit eligibility to help them through the process. It’s important to note too that companies who haven’t previously claimed the R&D tax credit can look at claiming it for previous still-open tax years.
Claiming the R&D Tax Credit – Required Steps & Documentation
Claiming the R&D Tax Credit involves the development and preparation of reporting that demonstrates the company’s qualification for it. This includes documentation of the R&D activities involved as well as information from one’s general ledger expenses, R&D results, payroll reports, and other relevant project documents. With these items in hand, a business would work with its payroll and/or tax services provider and finance function to calculate the amount of their credit and prepare and provide the information to their tax preparer.
Historically, companies were forced to rely on timesheet details and create a burdensome amount of upfront documentation to demonstrate qualification. While legal updates have since reduced some of the burdens on businesses regarding evidence of eligibility, it is still very important to be thorough with supporting documentation so that one’s claim is not later disallowed.
Cases In Point
As fractional CFOs, we support a diverse array of companies. In doing so, we’ve found several owners and leaders we interact with in these engagements holding on to one or more R&D Tax Credit misconceptions that were costing them money.
One instance involved an e-commerce company that simply sold a certain type of product online. They were unaware of their eligibility for the credit. However, we learned that they had developed a software application in-house to drive efficiencies in their warehouse and fulfillment operations. In working with vcfo and ADP, the company was able to qualify for a tax credit of more than $300,000.
In another instance, a startup company carried out activities aimed at solving the problem of too many inputs from social media, emails, Slack, and similar channels. We followed the same process with them and there too achieved a significant credit. With no profits as a result of being in the startup phase, and because they were less than five years old, the company was able to use the credit as an offset against their payroll taxes.
“R&D tax credits can pop up in some pretty unsuspecting industries mainly due to software development. vcfo did a great job uncovering a company in just this situation who, in not finding a software in the marketplace to fit their needs, developed their own software out of necessity. It resulted in a large tax credit that could have easily been overlooked had vcfo not been exploring all angles to help their client positively impact the bottom line of their tax return. R&D tax credits are often missed or underutilized but are one of the most lucrative tax credits the government has to offer for those companies who qualify.” Beth Celauro – Corporate Sales Manager, ADP Tax Credit Services
In summary, changes in recent years have expanded the availability of the R&D Tax Credit to a broader audience. While determining eligibility is relatively straightforward, details and thoroughness matter mightily when it comes to preparing and filing a federal tax return that includes the credit. That’s where having access to the right R&D Tax Credit experts and partners can play a major role in realizing significant credits for one’s company.
Need help determining your company’s R&D Tax Credit eligibility or preparing a claim? Request a Free Consultation from a vcfo expert who can help. We’ve partnered with more than 5,000 businesses in our 27 years and would love to share our expertise and experience with you.