The R&D Tax Credit: 5 Things to Know

Perhaps you have considered trying for the R&D credit in the past for your business, but you ruled it out. You may have weighed the benefits vs. the costs, and the documentation requirements alone made you decide that this insubstantial credit just wasn’t worth your time.

Or, perhaps you’ve gotten the message that this credit doesn’t apply to your type of business. Or maybe you’re still in start-up mode, and you’ll think about tax credits in the future, when your company is turning a profit.

There have been a number of good reasons why this credit has been underused by small- and medium-sized businesses. Information has been unclear, and hurdles have been high.

R&D imageI am happy to report some good news: Recent developments have made the R&D credit substantially more beneficial for many businesses, and now is an excellent time to take a new look at this. Doing so could amount to a few thousand additional dollars for your business R&D imageeach year – and possibly, quite a bit more.

Here are five good things to know now about the R&D tax credit:

1) Getting this credit can be simpler and more lucrative. Here’s the main reason why: A provision passed in June 2014 allows companies to submit an Amended Simplified Credit (ASC) on amended returns.

This might sound obscure … but stay with me!  As a matter of fact, the ACS provision is completely changing the math for many businesses, especially mid-sized and smaller. Because the ACS can now can be submitted on amended returns for all open tax years (usually three years plus the current year), the benefits can be much more substantial. For example, before this provision a small company might have received $25,000 for one year’s R&D credit, an amount the company may have deemed not worth the time and documentation required to get the credit. But under the new provision, by submitting amended returns, this same company can see credits of $100,000 or more.

Another big help for businesses is that getting this R&D credit is more user-friendly. Previously, companies were required to establish a strong case that they are creating innovative technology with thorough documentation – frequently, referencing developments going back for decades – to meet the IRS’s rigorous criteria for this R&D credit. And, calculating the credit amount was daunting in its complexity.

This has improved greatly. The IRS has a set list of criteria for what it considers to be valid R&D, and these criteria can apply to many types of product improvements and updates. While companies are still required to provide ample documentation to substantiate their claims, meeting the requirements can be much less of a battle than it has been in the past.

Also, with the new ACS, determining the credit amount is vastly simplified – again, making this process more feasible for smaller organizations. With the ACS, the tax credit is based on a simple formula: Averaging the previous three years of R&D investments, and then dividing that average number in half. The credit is 14 percent of any qualified expenditures over that number.

2) Timing-wise, this credit is much more useful for start-ups. Newer companies that can’t go back three years can use 6 percent of qualified research expenses for the current year.

And, an even more helpful provision is that the credits have a 20 year carry-forward period. Start-ups that do not have taxable income in their early years can take the credits in the future, when they have taxable income.

3) This is for real-world R&D in many types of industries, such as manufacturing, health care, and food processing, among others. If you are investing in finding ways to improve the performance or quality of your products, this credit can apply to you. The credit allows the use of “existing technologies,” because innovation happens across industries and can drive need for new products across markets.

Here is simplified example: A robotics breakthrough at a university opens up the possibility of improved automation for a factory that produces nutrition bars. This new automation technology is researched and developed, and the new design doubles the speed of nutrition bar production. This in turn, sparks designs for faster bar packaging equipment, as well as improved inventory tracking technology, more sophisticated logistics software, and so on.

The credit could apply to all of these innovations. The IRS has a set of criteria for what they consider R&D, but the overall idea for this credit is that it supports “applied science” just as much as “basic science.”

3) There are state R&D credits, too. If you meet the qualifications for federal R&D credits, you likely meet the qualifications for your state (most of which have R&D incentives in place). Minnesota, for example, provides credits for Minnesota-based businesses, as long as the R&D happens within the state.

4) Getting the R&D credit is simpler… but it’s still not that simple. Yes, progress has been made to make this funding more accessible, but obtaining the credits still requires some know-how. Multiple factors need to be considered and executed carefully. (Do you have adequate documentation of your R&D efforts? What materials, employee time percentages, and other costs qualify as expenses? Importantly, are you being consistent in how these expenses are classified from year to year?)

There is potentially a lot of money at stake here, and consequently, the IRS classifies the R&D credit as a “tier 1” issue. This means that you can expect higher levels of scrutiny. Bottom line, it is likely that you will want professional help with this.

Until very recently, obtaining these credits have been somewhat of a challenge for all but the largest of companies, with their legions of accounting professionals. Therefore, the actual distribution of this credit has been disproportionate, with the bulk of the funding going to a small group of large corporations.

Yet, small- and mid-sized businesses are primary drivers of American innovation and job growth. According to the Small Business Administration, 60 to 80 percent of new jobs are created in small- to middle-market businesses. Now’s the time for more businesses of all sizes to tap into this valuable source of funding!

Congratulations… You’ve read the list of 5 good things to know. Here are 2 main takeaways to remember:

1) It doesn’t hurt to ask! This funding is meant for many types of business, and self-censoring has been a main obstacle for small- and medium-sized operations to get their share. If you think there’s a chance this might apply to you, it’s worth asking your tax professionals. You could join the many businesses that are finally getting the credits they deserve!

2) Don’t hesitate! There’s still time to take advantage of this credit, if you contact your tax professionals about it now.

Good luck, and if you have a medium-sized or smaller business, thank you for your important role in American innovation and job growth.

Image credit: KarlSvensson99 (Own work) [CC BY-SA 3.0,via Wikimedia Commons

About the author

Brady is the owner of Ramsay & Associates. He specializes in financial statement preparation and personal, fiduciary and corporate tax and accounting.

His professional experience includes seven years' experience for local and national CPA firms before joining Ramsay & Associates in 2006.

He has a Bachelor of Accounting degree from the University of Minnesota Duluth. He is a Certified Public Accountant, a member of the Minnesota Society of CPA's, an Eagle Scout, as well as an active volunteer in the community.

Tax Extenders Bill Passes – With Two Weeks To Spare

Irs Federal Income Tax Forms 1040 And Schedule DBusinesses, individuals, and CPA’s around the country got an early holiday gift today as the Senate passed a tax extenders bill the President is expected to sign into law later this week.

The extender bill is quite similar to most we’ve seen in the past – this is the 6th tax extender bill passed near (or after) the end of the year in the last decade. This one puts back into place as of 1/1/14 a large number of benefits popular among taxpayers, but only keeps them in place through 12/31/14, so this debate will come again next year, but we’re happy to have these for now.

Among the more popular items extended for 2014:

  • $500,000 Section 179 limitation with a $2 million investment cap, up from the $25,000/$500,000 that would have been
  • 50% bonus depreciation on new fixed assets in service by 12/31/14
  • The Research and Development Tax Credit
  • Exclusion from income up to $2 million of debt forgiven on a principle residence foreclosure or short sale
  • $250 deduction for out of pocket expenses for teachers
  • Option to deduct sales taxes instead of state and local income taxes
  • Deduction of certain mortgage insurance premiums
  • Deduction of up to $4,000 for higher education tuition and fees
  • Ability to transfer up to $100,000 from an IRA to a charity with no tax
  • Ability to deduct up to $250,000 of qualified leasehold improvements up front
  • 15-year life for qualified leasehold improvements

About the author

Brady is the owner of Ramsay & Associates. He specializes in financial statement preparation and personal, fiduciary and corporate tax and accounting.

His professional experience includes seven years' experience for local and national CPA firms before joining Ramsay & Associates in 2006.

He has a Bachelor of Accounting degree from the University of Minnesota Duluth. He is a Certified Public Accountant, a member of the Minnesota Society of CPA's, an Eagle Scout, as well as an active volunteer in the community.

Waiting on Tax Renewals – In Santa’s Bag?

Irs Federal Income Tax Forms 1040 And Schedule DAs the end of the year approaches, we’re seeing the usual jockeying by Congress to clear their calendar of easy items before they all head home for the holiday break, and come back to a lame duck Congress and a President with nothing to lose. In all of this, the one thing missing so far is a tax extension bill.

The House and Senate had reached a compromise a few weeks back to extend the expired tax breaks in the short run, but that bill was threatened with veto by the President who thought it favored businesses and the wealthy over middle and low income Americans. The President also wanted extensions on the middle and low income tax breaks to run through 2018, an apparent attempt to keep a future Republican President and Congress from undoing what he’s done. This bill is dead.

Now, there is another bill coming out of the Republican controlled House to simply extend all of the expired items for the 2014 tax year, but Senate Majority Leader Harry Reid has indicated that it might not come up in the Senate, as they need to pass both a bill to fund the Federal government and a military funding bill before they can get to the tax extenders.

Either way, this will be yet another year that doesn’t see the tax code actually resolved until well after the end of the year, meaning confusion for taxpayers. Stay tuned.

About the author

Brady is the owner of Ramsay & Associates. He specializes in financial statement preparation and personal, fiduciary and corporate tax and accounting.

His professional experience includes seven years' experience for local and national CPA firms before joining Ramsay & Associates in 2006.

He has a Bachelor of Accounting degree from the University of Minnesota Duluth. He is a Certified Public Accountant, a member of the Minnesota Society of CPA's, an Eagle Scout, as well as an active volunteer in the community.

How to Write-off Your Kids for Tax Purposes

Young children in business clothes in the business center with cEveryone knows you can generally claim your children as dependents on your personal tax return, but there may be a way to also deduct them as a business expense.  Put them to work!  That’s right, hire them as an hire-your-childrenemployee if you own your own business.  Just remember, the work performed needs to be necessary to the business.  You might need that company car washed or someone to run to the post office every day, or go pick up office supplies.  If it would be reasonable to pay someone else to perform these tasks, you can pay your child to do it.  But be careful that the job is reflective of the child’s age.  You may pay your computer savvy 17 year old to design a website.  But you wouldn’t have your 8 year old do the same task.

Just remember to treat your child as you would any other employee.  This means setting a schedule, punching a time clock or sending them to training courses.  Their compensation must also be reasonable and consistent with what you would pay an outsider.  And as always, keep good records.

Not only can you deduct the wages paid to your children, but in certain instances you can also save on payroll taxes.  This means they take home more money in their paycheck and the business may not be required to pay Social Security and Medicare taxes (FICA).  Further, it’s a great way to shift income from your higher tax bracket to your child’s lower tax bracket and they may not even be required to file a tax return.  It’s also a great way to jump start their retirement by putting money away into an IRA.

 

About the author

Brady is the owner of Ramsay & Associates. He specializes in financial statement preparation and personal, fiduciary and corporate tax and accounting.

His professional experience includes seven years' experience for local and national CPA firms before joining Ramsay & Associates in 2006.

He has a Bachelor of Accounting degree from the University of Minnesota Duluth. He is a Certified Public Accountant, a member of the Minnesota Society of CPA's, an Eagle Scout, as well as an active volunteer in the community.

A Few Tax Mistakes To Avoid

While taxes are complicated, there are some mistakes that are pretty easy to avoid. Keeping the following items in mind will help to keep you out of trouble with the IRS.

  1. Not filing a tax return because you can’t afford the tax.  Paying taxes on time and filing a tax return on time are two separate issues, and have separate penalties.  Even if you can’t afford to pay the tax due, you should still file a tax return.  On the flip side, you should still pay the tax due even if you can’t get your tax return done on time.
  2. Never ignore notices from the IRS or state agencies.  Some people think the first couple notices are just warnings.  Don’t take the wait and see approach.  They won’t forget about you or just move on to your neighbor if you ignore them.
  3. Don’t pay taxes with high interest credit cards.  This is better than not paying taxes at all, but always look for other financing options first.  You can even work out payment plans with the IRS and most states for relatively small fees and low interest.
  4. Avoid refund loans.  Wait just a couple weeks and that refund check will arrive.  With an electronically filed tax return and direct deposit, you could see your refund in as little as a week.  In general it takes a couple weeks, but it’s better to be patient than to pay the fees associated with these refund loans.
  5. Don’t assume your tax software is smarter than you.  It’s easy to go to the office supply store, buy that tax software and answer all the questions and input some numbers.  But always look through the tax return before pressing the “send” button.  The tax programs out there can be good, but they can’t anticipate everyone’s unique situation.

About the author

Brady is the owner of Ramsay & Associates. He specializes in financial statement preparation and personal, fiduciary and corporate tax and accounting.

His professional experience includes seven years' experience for local and national CPA firms before joining Ramsay & Associates in 2006.

He has a Bachelor of Accounting degree from the University of Minnesota Duluth. He is a Certified Public Accountant, a member of the Minnesota Society of CPA's, an Eagle Scout, as well as an active volunteer in the community.