Research and Development Archives - MGO CPA | Tax, Audit, and Consulting Services

Unlock Savings with State and Local Tax Credits and Incentives

Key Takeaways:

Many businesses may miss out on significant savings by not fully using state and local tax (SALT) credits and incentives. But there are thousands available across state and local jurisdictions.
SALT programs offer valuable credits for job creation, capital investment, and research and development (R&D) — but companies often struggle with awareness, eligibility, and administrative challenges in utilizing these programs.
Third-party advisors can help businesses identify and maximize SALT savings while maintaining compliance. Properly leveraging SALT credits can provide a strong return on investment.

State and local tax (SALT) credits and incentives programs continue to be underutilized by taxpayers. Despite the substantial value they can add for businesses, BDO’s 2024 CFO Outlook Survey found that just 34% of CFOs plan to optimize costs by claiming tax credits in the next 12 months. This suggests that many companies could be leaving significant savings on the table.

There are myriad reasons why businesses do not take full advantage of SALT credits and incentives, even though those programs can be instrumental in unlocking cost savings for business activities such as upgrading existing facilities, relocating, building new facilities, and research and development (R&D).

There are thousands of credits and incentives available across state and local jurisdictions. Some companies lack awareness of the full range of credits and incentives available to them, while others may be aware of the programs but unsure of how to take advantage of them. The administrative burden of fully implementing awards once obtained can also be a barrier.

The benefits of tax credits and incentives can be a strong return on investment for companies able to take advantage of them, but many businesses lack the internal resources or expertise to navigate these opportunities effectively. This is where engaging with a third-party advisor may be a strategic value-adding measure.

Tax Credits and Incentives Refresher

Statutory tax credits can reduce a company’s overall tax liability — or in some cases provide a cash benefit for refundable or transferable credits — and may be available retroactively if applications are supported with appropriate documentation. Examples include statutory income/franchise tax credits and unique sales tax exemptions.

Tax incentives are generally broader than tax statutory credits and can come in the form of discretionary cash grants, negotiated abatements, unique exemptions and exclusions, and preferential tax rates. In many cases, they can offer above-the-line savings, making them appealing even to businesses operating at a tax loss. Examples include payroll tax rebates or property tax abatements.

Common SALT Credits and Incentives

The thousands of SALT credits and incentives available in the U.S. can vary widely, but some of their themes are consistent across jurisdictions. Below are a few of the most common SALT programs that are relevant to a large range of businesses.

Job Creation

Many jurisdictions offer credit and incentive programs to promote job creation. The most effective and typical incentive is a rebate of a portion or all of future payroll/withholding taxes for new jobs created for an expansion project. This type of incentive is highly lucrative because it is generally in place for at least 10 years. Negotiated incentives to reward job creation can generally be found in most states, but the Southeast continues to offer some of the best incentives.

Capital Investment

Capital investment incentive programs are designed to boost local economic development by supporting projects such as constructing new facilities, acquiring production equipment, or upgrading existing facilities. For example, an energy company that commits to a large-scale project to purchase a new piece of equipment may be eligible for income tax credits to offset a percentage of its investment costs. Other common opportunities include real and personal property tax abatements for new or improved facilities and investing in new equipment.

Utilities

As businesses across industries look to reduce their environmental impact, they might want to consider projects that may be eligible for credits and incentives, such as upgrading utility infrastructure, implementing energy-efficient systems, and enhancing water conservation. Across the nation, several jurisdictions offer utility tax credits, energy efficiency grants, renewable energy tax incentives, and utility rate reductions. These initiatives are often not limited to specific industries and can even be available to large nonprofit organizations such as hospitals, which may be eligible for a utility rate reduction without having to make any new investments.

Research and Development

States and jurisdictions across the country are vying to attract innovation by offering a variety of R&D credits to businesses in all industries. These programs can offset the cost of developing new products and processes, testing new or improved products and processes, enhancing existing products and processes, and creating prototypes. For example, an auto manufacturer seeking to develop longer-lasting batteries for electric vehicles may be eligible for credits or incentives to support researching or prototyping a new battery.

Benefits of Working with an Advisor

Lack of awareness of or a failure to understand eligibility are two of the most common reasons businesses miss out on available SALT credits and incentives programs. Many companies do not have in-house expertise to uncover these savings opportunities, but third-party advisors have the skills, relationships, and experience necessary to conduct the planning and analysis needed to determine which credits and incentives businesses should pursue.

Advisors can help tax leaders review their companies’ profiles and business strategies to uncover any past, current, or future opportunities. For example, a review of prior income tax returns could result in identifying retroactive refund opportunities.

Advisors can also review the programs offered by the various jurisdictions where the company operates, which, depending on the company’s size and scope, could represent savings opportunities in dozens of locations.

Advisors can take a comprehensive approach to reviewing all available opportunities or can tailor credit reviews to the most pertinent and strategic business needs.

They can also help leaders stay abreast of new credits in the locations where they operate and identify incentives and explore eligibility as they expand operations.

Further, advisors are critical in helping businesses collect the extensive documentation required to qualify for, take advantage of, and report their use of credits and incentives programs. This compliance work can be challenging for a company’s in-house tax team to navigate, so outsourcing it can provide valuable time savings. It can also help ensure companies are taking full advantage of their awards.

How MGO Can Help

As a third-party advisor, we uncover credits and incentives applicable to your business profile and strategy, particularly in areas where you plan to operate or expand. Staying at the forefront of new incentives and programs, our team helps you benefit from the latest opportunities — matching your needs to available programs at the federal, state, and local levels. We work with both statutory and non-statutory programs, collaborating closely with relevant authorities.

SALT credits and incentives are a critical component of tax planning and should be explored to determine how they can support your overall business strategy or create opportunities for retroactive or above-the-line savings. To learn more, reach out to our team today.

Is Your Manufacturing Company Missing Out on R&D Tax Credits?

Key Takeaways:

R&D tax credits reduce tax liability and provide a financial boost for manufacturing companies investing in innovation.

Qualifying for R&D tax credits involves creating new or improved products or processes and requires thorough documentation.

Misconceptions about R&D tax credits limit potential benefits. Both large and small companies can qualify for incremental improvements.

In the ever-evolving landscape of manufacturing, innovation is still the cornerstone of success. Yet, amidst the constant drive for advancement, many manufacturing companies overlook a valuable opportunity to enhance their financial health: research and development (R&D) tax credits.

These incentives are designed to reward your company for research and development efforts, providing a significant financial boost. Understanding and using these credits can make a substantial difference to your company’s bottom line.

Understanding R&D Tax Credits

R&D tax credits are federal incentives aimed at encouraging companies to invest in innovation. These credits are available to businesses that engage in activities related to developing new products, processes, or technologies. The scope of qualifying activities is broad — encompassing everything from developing new software systems to refining manufacturing processes.

For manufacturing companies, this means a wide range of projects could potentially qualify for these credits. Whether you are creating a new product line, improving existing products, developing more efficient production methods, or designing, there is a good chance your efforts could be eligible for R&D tax.

The Financial Impact

The financial benefits of R&D tax credits are considerable. These credits directly reduce your tax liability on a dollar-for-dollar basis. Essentially, for every dollar invested in qualifying R&D activities, a part of this cost can be recouped through these credits.

This reduction in tax liability can significantly enhance your company’s financial statements — freeing up capital for reinvestment in further innovation and growth. Additionally, for certain taxpayers under qualifying criteria, R&D tax credits also can be used to offset payroll tax liabilities.

R&D tax credits are not limited to federal taxes either. Many states offer other incentives, creating an even greater opportunity for financial savings. By taking advantage of both federal and state R&D tax credits, your manufacturing company can maximize its benefits.

Qualifying for R&D Tax Credits

To qualify for R&D tax credits, your company must engage in activities that align with the Internal Revenue Service (IRS) definition of research and development. The IRS uses a four-part test to decide eligibility:

Permitted purpose: The activity must aim to create a new or improved product or manufacturing process. This could involve designing a new part, developing a more efficient assembly line, or creating a product with enhanced functionality.

Elimination of uncertainty: The activity must look to analyze and eliminate technical uncertainty about the development or improvement. For example, this might involve deciding the best materials to use in a new product or figuring out how to streamline a production process to reduce waste.

Process of experimentation: The activity must involve a process of experimentation, such as systematic trial and error. In a manufacturing context, this could mean testing different prototypes, experimenting with various production techniques, or conducting pilot runs to evaluate the feasibility of new methods.

Technological in nature: The activity must be based on principles from physical or biological sciences, engineering, or computer science. For manufacturers, this often includes using advanced engineering principles, integrating new software systems into production lines, or applying scientific research to improve product quality.

Documentation is critical in this process. Detailed records of your R&D activities — including project descriptions, expenses, and outcomes — will support your claim and confirm compliance with IRS requirements. From the first hypothesis to final testing, keep thorough documentation of every step to substantiate your eligibility for R&D tax credits.

Common Misconceptions

Many manufacturing companies believe R&D tax credits are only for large corporations with dedicated research labs. This is far from the truth. Businesses of all sizes can qualify for R&D credits, and the types of activities that qualify are often broader than many realize.

Other common misconceptions:

R&D tax credits only apply to groundbreaking innovations.

The process to identify and capture these credits is too cumbersome.

In reality, both these beliefs are unfounded. It’s not just groundbreaking innovations — incremental improvements to products or processes can also qualify. If your company is making strides in efficiency, quality, or performance, these efforts may be eligible for R&D tax credits. And capturing these credits doesn’t have to be cumbersome. Engaging the services of a trusted professional will help you efficiently and effectively work through the process.

Maximizing Your R&D Tax Credits

R&D tax credits are not just a way to reduce your current tax liability; they are also a significant tax-planning tool. These credits can reduce estimated tax payments and income taxes, thereby increasing cash flow and influencing future financial planning as your company grows.

To maximize the benefits of R&D tax credits, you need to implement a strategic approach. Consider these key steps:

Find qualifying activities: Conduct a thorough review of your operations to find all potential R&D activities. Look beyond obvious projects to uncover less clear qualifying activities.

Maintain detailed documentation: Keep comprehensive records of your R&D projects — including goals, methodologies, and expenses. Proper documentation is essential for substantiating your claims.

Consult with tax professionals: Work with tax advisors who specialize in R&D tax credits. They can help you navigate the complexities of the application process and improve your claim.

Review and update annually: Regularly review your R&D activities and expenses to confirm you are capturing all eligible credits. As your company evolves, so will your R&D activities.

Unlock Your Potential with R&D Tax Credits

R&D tax credits are a powerful tool for manufacturing companies striving for innovation and growth. By understanding the eligibility criteria and keeping diligent documentation, your company can unlock significant financial benefits.

Do not let misconceptions prevent you from exploring this valuable opportunity. Engage with knowledgeable tax professionals to navigate the process and maximize your benefits.

How MGO Can Help

Our dedicated Tax Credits and Incentives team can help your manufacturing company leverage R&D tax credits to support your innovation. Reach out to our team today to learn more.

4 Step Guide to Securing R&D Tax Credits for Your Company

Key Takeaways:

Thorough documentation is essential for maximizing R&D tax credit claims by linking innovative projects to the required criteria set by authorities.

Critical documentation methods include maintaining project plans, reports, communications, time sheets, expense logs, and categorizing all records by project with clear dates.

To substantiate experimentation, continuously update digital records like lab notes and version-controlled documents to detail hypotheses, trials, iterations, findings, and modifications.

For companies in industries like manufacturing, biotech and life sciences, and technology, navigating the complex world of research and development (R&D) tax credits can be challenging. Thorough documentation is the key to maximizing your claim. Effective R&D tax credit claims hinge on robust documentation. Establishing the link between your innovative projects and the tax credit criteria set by authorities is non-negotiable.

Maximizing R&D Tax Credits: A Checklist for Robust Documentation

From ideation to execution, every step of your R&D project must be documented with precision. Follow these guidelines to assist your efforts:

1. Foundation and Focus of Documentation

Lay the foundation for your R&D tax credit claim by aligning your innovative endeavors with the IRS’s qualifications. It is critical to consistently document every aspect of your projects, from initial goals and research stages to the hurdles you overcome and the novel outcomes you achieve. Your documentation needs to center on and address how your activities relate to the required four-part test: developing a business component, relying on science or technology, aiming to eliminate uncertainty, and involving a process of experimentation.

2. Documentation Methods and Best Practices

Incorporate a variety of records into your R&D documentation system — such as project plans, reports, and communications. For optimal organization, make sure each document is clear, concise, and bears a date stamp. Then categorize all documents by project, which aids in retrieval and review. Keep detailed records of project developments, discussions, and decisions to facilitate a straightforward audit process.

3. Tracking and Proving Your R&D Work

Maintain a log of your qualifying R&D activities and concurrent developments, clearly articulating how these relate to expenses. Accurate and up-to-date records like time sheets and expense logs are essential. Organize and categorize all R&D costs — from personnel and materials to outsourcing and cloud computing — employing accounting software for uniform expense coding. This methodical record-keeping is essential for connecting R&D endeavors with their associated costs, ensuring this support is available and complete in the event of an IRS audit.

4. Showcasing Experimentation

Substantiate technological progress with thorough records of your experimental activities. Continuously update digital records to reflect the evolving nature of your R&D projects, capturing each hypothesis, trial, and iteration. Make certain these digital records, like lab notes and version-controlled documents, comprehensively detail the experiments, findings, and any modifications to procedures or products.

Unlock R&D Tax Credits to Drive Your Business Forward

Navigating the intricacies of R&D tax credits is a continuous process that demands thorough documentation and strategic planning. By adhering to the four guidelines above and meeting the four-part test, businesses can not only ensure compliance but also maximize their potential benefits. As you embark on this journey, remember each detail documented is a step towards fostering innovation and technological advancement within your company.

MGO offers a comprehensive suite of strategic financial services to support your R&D endeavors. Reach out to us today to find out how we can help you.

Fueling Your Future: Harnessing R&D Tax Credits for Innovative Growth

Key Takeaways:

R&D tax credits incentivize innovation by reducing tax liability and providing cash flow for companies to reinvest in research.

Current legislation proposes delaying R&D cost amortization, advocating immediate expensing through 2025 to boost U.S. innovation.

To maximize R&D tax benefits, companies must strategically align projects with eligibility criteria, maintain documentation, choose the optimal claim path, and tailor strategies to industry-specific nuances.

In the competitive global market, staying at the forefront of innovation is not just a goal but a necessity for businesses of all sizes. Noting this, the U.S. government established a pivotal incentive to reward and encourage investments in research and development (R&D). R&D tax credits serve as a cornerstone for companies pushing the boundaries of innovation and technological progress.

Empowering Innovation Through Tax Incentives

The beauty of R&D tax credits lies in their dual benefit structure. Not only do they reduce tax liability for your business, but they also enhance cash flow — allowing reinvestment back into your company’s innovation pipeline. This reinvestment is vital for continuous improvement and long-term success, particularly for startups dreaming big and established companies refining processes and products. R&D tax credits are not just a tax strategy; they are a fundamental part of your growth narrative.

Whether you are a fledgling tech startup aiming for the next big breakthrough or a seasoned manufacturer improving existing processes, R&D tax credits offer widespread applicability. They represent a commitment to supporting the growth and innovation journey of businesses across various sectors, from AI and green energy to biotech and manufacturing.

Legislative Efforts Amidst Challenges

The Tax Cuts and Jobs Act (TCJA) introduced in 2017 made significant changes to R&D tax incentives, shifting from immediate expensing of R&D costs to a more burdensome five-year amortization. However, in a move to rejuvenate the innovation landscape, the Tax Relief for American Families and Workers Act of 2024 has been proposed to delay this amortization, championing immediate expensing through 2025. This legislative initiative underscores the economic imperative for the U.S. to maintain its global leadership in innovation and technology.

While there is bipartisan support for the importance of R&D incentives, with key proposals awaiting Senate action, the legislative landscape is not without its challenges. The proposed Fiscal 2025 Budget by President Biden earmarks substantial investments in innovative sectors to complement the tax incentives. However, the legislative progress faces hurdles with ongoing debates over government funding, potentially delaying critical policy adjustments necessary for the R&D tax incentives to realize their full potential.

Strategizing to Maximize Your R&D Benefits

For your business to capitalize on these incentives, you must align with the stringent four-part test that stipulates qualifying R&D activities must be:

Technological in nature

Aimed at permitted purposes

Directed towards the elimination of uncertainty

Entail a process of experimentation

Maintaining rigorous documentation is essential, linking projects directly to these eligibility criteria. Choosing the right claim path — against income or payroll tax — can also determine the extent and immediacy of the benefit. Furthermore, industry-specific insights can guide your company on how to tailor your R&D strategies — acknowledging that some activities may qualify more readily based on your industry’s nature.

How We Can Help

MGO’s Tax Credits and Incentives team can help you turn tax expenses into positive cash flow. Reach out to our team today to find out how you can leverage R&D tax credits to grow your business.

Is Your Tax Advisor Discussing These 4 Key Tax Developments in 2024?

Key Takeaways:

Businesses must now capitalize Research & Experimental (R&E) expenditures and amortize them over 5 or 15 years, significantly impacting cash flow and project viability for innovation-driven enterprises.

The gradual phase-out of bonus depreciation rates necessitates a reevaluation of capital expenditure strategies and their tax implications.

Mergers, acquisitions, and international transactions can come with complex tax consequences. Proactively engage with your accountant to navigate compliance, optimize tax positions, and leverage strategic planning opportunities.

You turn to your tax advisor to learn how the latest tax law changes will impact your organization. But does your advisor reach out proactively to discuss how upcoming changes might impact your business and its tax liabilities?

As we progress through 2024, several significant tax developments may impact how you make business decisions and manage your tax obligations. Is your accountant aware of these changes and, more importantly, actively discussing the implications and opportunities with you?

1. Research and Experimental Expenditures

Internal Revenue Code (IRC) Section 174 was one of the most radical components of the Tax Cuts and Jobs Act (TCJA) of 2017 and continues to create questions for corporate tax departments today. It requires your company to capitalize and amortize Research and Experimental (R&E) expenditures over five years (15 years for the research performed outside of the U.S.) instead of deducting them in the year incurred.

Losing the ability to deduct R&E expenditures can significantly increase your taxable income, impacting cash flow and project viability.

Your accountant should guide you through the implications of this change, helping you maintain records linking expenses to qualified research activities and maximizing your R&D tax credits.

2. Accelerated/Bonus Depreciation Phaseouts

Another significant change from the TCJA that might catch you off guard is the phaseout of accelerated and bonus depreciation.

As a reminder, the bonus depreciation rate was 100% in 2022 but dropped to 80% in 2023. It will continue to drop by 20% each year until bonus depreciation is unavailable in 2027 (assuming Congress doesn’t enact new tax law changes).

This gradual reduction impacts your ability to deduct the cost of capital expenditures, affecting your tax liability and financial planning strategies.

Despite the phaseout, there are still planning opportunities for companies to consider. For example, you might accelerate planned equipment purchases before year-end, use a cost segregation study to accurately categorize building components into asset classes with shorter recovery periods, and continue to take advantage of Section 179 expensing rules.

Your accountant should proactively discuss these changes with you to help you make informed decisions about capital investments.

3. Foreign Sales – FDII Deduction

The Foreign-Derived Intangible Income (FDII) deduction represents a significant tax-saving opportunity if your company has foreign sales.

FDII is income from the use of intellectual property — legally protected, non-physical assets in the United States used to create an export.

You can deduct 37.5% of your FDII against taxable income, effectively reducing the tax rate on each dollar of FDII to just 13.125%. However, the FDII deduction will be reduced after 2025, at which point the effective tax rate will rise to 16.4% under current law.

Your accountant should actively inquire about foreign sales activities and advise on the potential benefits of the FDII deduction, so you do not overlook valuable tax savings.

4. M&A and Cross-Border Transactions

Mergers and acquisitions (M&A) and cross-border transactions present a complex array of tax considerations.

Cross-border transactions can include any transaction outside of the U.S., including receiving interest or royalties from a foreign entity or making sales in a foreign country (whether to an unrelated third party or a related entity). These transactions can come with transfer pricing considerations, foreign tax consequences, and reporting requirements in foreign jurisdictions.

In the mergers and acquisitions space, your accounting firm can help with various issues, including buy- or sell-side due diligence, risk mitigation, structuring the transaction as a stock sale or an asset sale, analyzing transaction costs, and determining whether you can deduct or capitalize those costs.

Whether you’re contemplating a transaction or have recently completed one, your tax advisor can provide support in navigating the tax implications, ensuring compliance, and optimizing your tax position through strategic planning and structuring.

Unlock the Power of Proactive Advice

The tax landscape in 2024 includes significant changes and opportunities. From how businesses account for R&E expenditures to the strategic implications of FDII deductions, and the potential tax benefits, these developments require careful consideration and strategic planning.

To navigate these changes effectively, engage with a team of advisors who are aware of these developments and prepared to discuss their implications for your business. Reach out to an MGO advisor today.

R&D Tax Credit: IRS Focuses on Process of Experimentation (POE)

When the IRS first came up with the Research and Development (R&D) Tax Credit, the industries it impacted were primarily scientific organizations and lab-based research companies. Today, eligibility has expanded to the point that most businesses in almost every industry can claim the credit, if they are performing research, and importantly, documenting it.

The R&D credit is a valuable tax tool, but it is complex and has attracted the attention of the IRS from the beginning. As recently as July 2021, the IRS made it clear that it was continuing to focus on those claiming the credit especially as it relates to the substantiation of qualified research. But attention from the IRS shouldn’t dissuade eligible businesses from claiming it.

Qualifying for the R&D credit

There are four requirements to qualify for the R&D credit. The business activities must:

Be intended to eliminate technical uncertainty about the development or improvement of a product or process
Constitute a process of experimentation
Be technical in nature and adhere to the standards of hard science
Relate to the development of a new or improved business component

Of all the qualifying requirements, the one that seems to create the most challenges for small businesses is documenting the process of experimentation (POE) in R&D projects.

Product development process

Having a well-documented product development process is just good business practice, but it also makes an IRS audit considerably smoother. If your business follows regulatory or industry standards on how products should be developed and tested, your documentation work is essentially done. However, even without formal industry standards, outlining how products are created, tested, and released will provide the information required by the IRS to demonstrate that you have a formal POE.

Documenting your POE

So, what does the IRS consider proper documentation of your POE? There are a few basic elements that will help make your case to the IRS.
• Project accounting systems that track employee time and project costs provide the level of detail the IRS values.
• Technical project documentation that highlights the process.
• Technical documentation such as design drawings and revisions, patent applications, regulatory submissions, product tracking, and workflow logs.

The best practice for R&D credit documentation is to compile them systematically as you produce them, so you don’t need to search for them later or recreate them. If you clearly define, document, and allocate costs to the specific business components, claiming the tax credit can be a reasonably smooth process.

How we can help

MGO helps organizations across a wide range of industries develop and implement procedures to document their R&D activities. We help clients demonstrate their eligibility for the R&D credit and claim the credit available.

About the author

Michael Silvio is a partner at MGO. He has more than 25 years of experience in public accounting and tax and has served a variety of public and private businesses in the manufacturing, distribution, pharmaceutical, and biotechnology sectors. He can be reached at [email protected].

Are You Maximizing R&D Tax Credit Benefits?

The Research and Development (R&D) tax credit is a commonly underutilized, yet powerful, tax incentive available for companies to substantially reduce their tax liability, improve their bottom-line, and reinvest back into their business. Daily activities performed by companies in a wide range of industries may qualify for federal and state R&D tax savings.

Unfortunately, R&D tax credits are also one of the most misunderstood methods of tax relief because there are many false assumptions about what is needed to qualify. In the following overview we’ll provide a brief description of the R&D tax rules, qualification criteria, and useful tips to maximize potential benefits. This article focuses specifically on federal R&D tax credits but there are also 40 states that provide R&D tax credits, each with its own set of rules and qualification criteria.

You don’t have to be scientists in white lab coats to qualify

For more than 40 years, companies have taken advantage of the R&D tax credit, claiming roughly $10 billion per year in tax savings. This powerful tax credit is not just available to large companies or companies employing hundreds of scientists. Companies of all sizes, in many different industries, may qualify for R&D tax credits including those working in software, manufacturing, aerospace and defense, agriculture, food and beverage, and life sciences. Even startups that have not yet generated taxable income may be able to monetize the R&D tax credit by claiming these R&D credits against their payroll tax liability.

There are many rules to claim an R&D tax credit but simply stated, if your company is involved in the technical development of new or improved products, or processes that require the undertaking of a systematic evaluation of multiple alternatives, to achieve the desired result, you may qualify. This applies to new product development, product enhancements, software development, manufacturing process improvements, and the list goes on…

Benefits of R&D tax credits for startups and small businesses

Unfortunately, many small businesses do not take advantage of this tax benefit because they self-censor, believing that their business will not qualify.

The Protecting Americans from Tax Hikes Act of 2015 opened the door for companies with little to no income tax liability to monetize the R&D tax credit. Eligible small businesses are now able to take the R&D credit against their alternative minimum tax liability. Eligible small businesses are defined as corporations that are not publicly traded, and are corporations, partnerships, or a sole proprietorship with average annual gross receipts not exceeding $50 million for the three taxable years preceding the current taxable year.

Startups with no more than five years of gross receipts and less than $5 million in gross receipts can also take advantage of the R&D tax credit incentive to offset up to $1,250,000 (over a five year period) of their Federal Insurance Contributions Act payroll taxes.

Benefits of timely capture of R&D tax credits

Even though a company may not be paying tax and may not be able to utilize the R&D tax credit currently, there are still good reasons to claim the credit. One of these reasons is that it is always easier to identify and document these credits while the supporting information is available and “fresh” in everyone’s minds. Waiting too long or until the company is profitable may be too late to capture the credits effectively, efficiently, and completely.

Another reason to choose to capture these credits in a timely fashion is because these credits can become extremely valuable in a sale transaction. Accumulated research and development credits can impact purchase price in an M&A or other deal, as a buyer may be inclined to pay more for the company if it has accumulated research credits (subject to IRC Sec. 383 limitations) and also if it has infrastructure in place to capture these credits on a “real time” basis.

Additionally, the accumulated credits may also be able to be used to offset the tax as result of a sale transaction. These credits may be able to offset the tax at the corporate level in the event of a C corporation sale or at the shareholder level in the event of pass-through entity sale.

The four-part R&D tax credit test

The criteria established by the following R&D four-part test will help to determine if your business qualifies for the R&D tax credit.

1. Technological in Nature – The activity performed must fundamentally rely on principles of engineering, computer science, physical or biological science.

2. Process of Experimentation – The company must demonstrate that they have undertaken an iterative development process, evaluating alternatives to eliminate uncertainty.

3. Elimination of Uncertainty – The activity must be aimed at eliminating uncertainty with respect to the development of a product or process.

4. Permitted Purpose – The activity must be intended to develop a new or improved business component.

Reviewing the tax code requirements and the company’s eligible activities should be the first step in the process of identifying potential R&D tax credits. Due diligence is required when adhering to the R&D tax credit rules and calculating and documenting the company’s qualified research activities. On the surface the rules may not seem complicated but there are many steps to claiming R&D credits – and many complicated tax court cases and a lot of misinformation that can make R&D claims confusing.

Importance of R&D tax credit documentation

To meet the requirements for the R&D tax credit, a history of the business’ qualifying activities must be documented. Documentation of R&D efforts can be challenging because employees may work on several projects at once and perform different types of duties. To address this, it is important to segment qualified R&D activities from all other work performed. Thankfully, today’s payroll systems can be programmed to track qualified research wages to qualified research projects.

The R&D tax credits may be claimed for both current and prior tax years, so it is recommended that companies document their R&D activities, so they’re well positioned to claim the credit for both situations.

The types of documentation that can be used to substantiate R&D labor expenses include:
• Time tracking data
• Employee W-2 forms
• Project lists
• Payroll registers
• Time questionnaires
• Job descriptions
• Meeting minutes
• Lab results
• Interview notes provided for oral testimony

Common misconceptions about R&D tax credits

Today, more companies than ever are qualified to take advantage of the R&D tax credit. However, many businesses still have reservations and don’t believe they will qualify based on misconceptions about how the tax credit may apply to their business. Some of these misconceptions include:

• They don’t believe they do R&D work – The definition of R&D work is broad. If the business is attempting to develop or improve a new product or process it may qualify for the R&D tax credit.

• They don’t believe they are inventing anything – There is no requirement that product or processes be successful or new to the world.

• They believe the risk of an audit will increase – The R&D tax credit is a permanent incentive intended to promote innovation in the U.S. Claiming R&D credits on timely filed tax returns, whenever possible, is encouraged and in most cases does not trigger an audit. However it is imperative that the taxpayer collect and retain proper documentation to support any R&D tax credit claim.

Claiming the R&D credit

A taxpayer shouldn’t feel intimidated by preconceived notions of what R&D is or what companies can qualify. Across industries, the possibilities for qualifying activities exist, and vital tax savings may be uncovered to be used for future projects.

At MGO, our professionals bring more than 30 years of R&D tax experience to help you file and defend your R&D tax credit claim. We welcome the opportunity to provide your company with a complimentary R&D tax credit eligibility analysis to determine if this tax incentive can help fuel your company’s growth.