Nine research and development tax credit myths costing you money

The R&D tax credit is only for companies that invent something revolutionary.

The R&D tax credit is designed to encourage innovation. As such, it is equally available to companies that attempt evolutionary improvements to existing products or processes and companies that undertake revolutionary activities. The development or improvement effort does not have to equate to a moon shot. The regulations define research as activities constituting a process of experimentation “intended to eliminate uncertainty” based on information available to the taxpayer at the outset of the project. An experienced R&D tax professional can help you understand what types of activities meet the qualifying criteria.

The R&D tax credit is only for companies engaged in basic research.

The R&D tax credit also extends to applied science, something that many companies perform on a daily basis as they try to improve their business and production processes through the use of technology and science.

The R&D tax credit is not available for companies that fail in their research.

You do not have to be successful to claim the credit. The R&D tax credit is an efforts-based credit. In fact, the regulations specifically state that success is not required in order to be eligible.

The R&D tax credit won’t help my company because my company is not profitable.

It is true that the federal R&D tax credit is a credit against taxes, meaning you must be profitable to utilize the credit. However, the credit carries forward 20 years and back one year. Thus, it could be of immediate benefit if your company was profitable in the prior year and can be banked for use in future profitable years. Also, small start-up companies may now be able claim a credit against their payroll tax even if they pay no income tax. In addition, some state R&D credit programs provide for refundable credits.

The R&D tax credit is only for big companies.

While large companies may claim the biggest and most headline-grabbing credits, the program is open to all companies. There are no company size requirements; the credit is only based on engaging in qualified activities. The credit, however, must be actively claimed; it is not automatically granted. In 2013, more than 16,600 companies claimed the credit. Fifteen percent, or 2,421, of these companies had business revenues below $25,000, and 45 percent, or 7,399, companies had revenues below $5 million.² In other words, approximately half of the companies that claim the federal research tax credit are considered middle market companies or small businesses.

The R&D tax credit is not available to my company because our research is funded by the government.

This is an understandable misconception that invites deeper consideration. The R&D tax credit requires both technical uncertainty and financial risk. If a contract between the government (or other party) and the taxpayer requires the taxpayer to succeed or return funds, or to incur costs beyond what the government is paying, the taxpayer is at financial risk and thus eligible for the R&D tax credit. A determination can only be made by reviewing all of the contractual payment provisions. Taking the time for a thorough review usually proves rewarding.

The R&D tax credit doesn’t reduce state taxes.

About two-thirds of states have an R&D credit program. As mentioned previously, some of these offer refundable credits, while others offer credits that can be carried forward. Most state eligibility requirements mimic federal eligibility requirements, though some may restrict, include or provide for enhanced credits for specific types of research. The most common differences between federal and state R&D credit computations relate to the credit rate and base amount computations.

The R&D tax credit is not a big deal since my company is already getting a deduction.

Smart tax planning includes taking advantage of all available benefits. An election under section 280C(c)(3) allows a taxpayer to take a reduced credit without disallowing the deduction for R&D expenses. Thus, a taxpayer may take a deduction for qualified R&D expenses in addition to a reduced credit at the tax-effected rate of 79 percent of the full credit rate. The reduced credit is in addition to the deduction and represents a dollar-for-dollar reduction in regular income tax liability. Why leave money on the table and potentially put your business at a competitive disadvantage?

The R&D tax credit is for increasing research; since my spending is flat, my company is not eligible.

This is another tricky area full of misconceptions. The R&D credit does require an increase in research spending. However, current-year spending is compared to a base, which is 50 percent of the average spend for the prior three years, calculated under the ASC method*. In reality, your company’s research spending could actually be decreasing, and your company could still be eligible for the credit.