The research tax credit provides companies a competitive advantage and encourages growth, yet there remain many companies who are failing to take advantage of the credit due to some common misconceptions.
Below are some of those misconceptions and an explanation of why they are incorrect.
- We’re Not Profitable, So We Don’t Qualify
The research credit was originally enacted as a reduction of income tax liability. For over 30 years the research credit would temporarily expire every 12 to 24 months, until the PATH Act of 2015 permanently extended it. The PATH Act also made the credit impactful for start-ups, allowing them to use the credit to offset payroll tax rather than income tax.
Businesses with less than $5 million in current year gross receipts can use the research credit to offset payroll tax for the first five years they generate receipts and use up to $250,000 annually of their research credit (up to five years) to offset payroll tax liability. (This election must be made on an original, timely-filed tax return.)
So, even if you aren’t profitable, you can still use that tax offset for your payroll taxes if your first recorded revenue was within the last five years.
On multiple occasions, companies have shared that it had been over six years since they registered their first revenue. At the time, they thought that it didn’t make sense to pursue the credit because they weren’t profitable; now, they had run out of time to qualify for the payroll offset. It was painful watching them do the math of how much they’d left on the table.
- We Were Told Our Government Contract Work Doesn’t Qualify
This is probably the biggest misconception out there regarding the research tax credit. The thought is: why would the government give me a credit if they pay me to do the work?
Adding to the confusion, Sec. 41(d)(4)(H) dictates that “Funded Research” is excluded as qualified research expenses. It defines it as:
IRC §41(d)(4)(H) FUNDED RESEARCH – Any research to the extent funded by any grant, contract, or otherwise by another person (or government entity).
That definition is the sole reason why companies have been misinformed by their provider regarding their government contract work and it costs them impactful dollars.
For government contractors, there are three questions to ask yourself to determine whether your government contracts could qualify:
- Does my project pass the four-part test?
- Do I retain some part of the IP?
- Am I at financial risk?
If you don’t know the answers to those questions, that’s ok. Talk with an expert who can walk you through the steps to help you identify whether your work qualifies or not. If you decide to approach your current provider to investigate this and hear “we have looked into and there’s nothing there,” or “we are already maximizing the credit,” warning bells should be ringing.
A $1,000,000, firm-fixed government contract has the potential to add $50,000 to your credit calculation. If you are a government contractor that has looked into this credit but been told repeatedly that it doesn’t qualify, are you willing to risk that it does?
- The Research Tax Credit Study Is An Accounting Function
The final credit amount is something that is put on a tax form, so most companies believe their accountant or accounting firm should be an expert and know the ins and outs of the credit. While most accountants and accounting firms provide great customer service and are good at what they do, the research tax credit is a study rooted in engineering, not accounting.
If you claimed a research tax credit and you found out you were to be audited on that credit by the IRS, the IRS most likely would use degreed engineers to determine whether your project or technology qualifies for the credit. If the IRS uses engineers to make that determination, who would you rather having defend your claim: accountants or engineers?
- This Is Too Good To Be True
Just because you haven’t heard of it doesn’t mean it doesn’t exist. The research tax credit has been around since 1981, and it is common practice.
The R&D credit is the most impactful tax credit available for companies. Because of that, the IRS doesn’t just willingly hand it out. Just like we mentioned above, you NEED to have the proper documentation of your activities and ACCURATELY apply the law to maximize the benefit. However, the right team can make that easy.
If you have been told you don’t qualify for the research tax credit, you believe you’re not maximizing the credit, or are concerned your documentation wouldn’t withstand an audit, contact us.
About: John, Business Development Specialist, has a finance degree from Miami University. He lives in Indianapolis with his wife and three kids. When not spending time with his family, you can usually find him on a golf course.