Companies are always looking to maximize the net proceeds from the business. Once the total income has been determined, there are two main ways companies can reduce their tax burden: deductions and credits. A deduction is an “above the line” reduction in taxable income and a credit is a “below the line” reduction in taxes owed (here is the 2018 Federal form 1120 for reference).
Decreasing income by Cost of Goods Sold (COGS), amounts paid in salaries and wages, operating expenses, depreciation, etc., all reduce the net taxable income. As such, at the 21% corporate tax rate, reducing taxable income by expenses totaling $100,000 will result in a $21,000 tax savings. However, the powerful component of credits is that they are applied directly to the computed tax liability instead of being treated as a deduction to calculate the tax liability. Therefore, the biggest benefit to the company is to utilize tax credits since every dollar of tax credit is worth over approximately $4.75 in deductions at the 21% tax rate.
As credits increase the overall net amounts retained by the company, they also impact the company profit. With this idea in hand, a $50,000 credit is worth approximately the same as over $250,000 in deductions. When looking at profit margins, that same $50,000 in credits is worth even more. For a company with a 10% margin, the impact of that credit is the same as $500,000 in revenue. If the company has even tighter margins at 5%, its worth $1,000,000 in revenue.
Because the Research and Experimentation Tax Credit is applied against the tax liability, it can be a very powerful way to manage cash flow and have more funds available for other uses within the company. This enables the company to continue to reward shareholders, hire more engineers, or other planning items. On amended returns, the credit (down to the minimum allowed tax) is refunded to the company or shareholders with any excess credits being carried forward. In addition, many states offer research credits as well, with only a small addition in effort required to capture those benefits once the federal credit has been documented.
About: Ariane, Engineering Director, is a degreed electrical engineer and has been with Hull & Knarr since 2006. She lives in Columbus, Indiana, with her husband, 2 kids, and a cat.