The qualifications for the R&D tax credit are much broader than what people typically think of as R&D. If a company is developing new or improvements to existing products or processes they likely qualify for the R&D tax credit.
Recent changes to the federal R&D credit
In late 2015, Congress made the R&D credit permanent. Since its inception in 1981, taxpayers have faced an uncertainty with the R&D credit status. The credit was allowed to expire and had to be extended, sometimes retroactively, 16 times, affording companies a limited ability to plan and budget for additional R&D activities in future years. With the credit made permanent, many taxpayers finally feel confident about investing in future R&D activities.
In addition to the permanent extension, the R&D credit now offers two additional taxpayer friendly changes. First, start-up companies with less than $5 million in gross receipts and in their first 5 years can use the credit to offset the employer portion of FICA payroll tax, at up to $250,000 each year. This will enable companies to monetize the credit even if a company is not in a taxable position. Second, small companies with less than $50 million in average gross receipts can utilize the credit to offset Alternative Minimum Tax (AMT). This benefit is especially key for owners of pass-thru companies who may have been limited in utilizing the credit in the past.
State R&D credits
Many states also have a R&D tax credit. In fact, activities that qualify for the federal R&D credit can also qualify for a state level credit. Notably, the state of Georgia has one of the most taxpayer friendly R&D credits. The Georgia credit can be up to 10 percent of qualifying expenses, which, for some taxpayers, is a better benefit than the federal credit. However, the benefit of the Georgia credit doesn’t stop there. For companies that don’t have any Georgia income tax liability, an election can be made to utilize the credit against Georgia payroll tax withholding.
At first glance, many taxpayers underestimate this benefit, asking “Why is this so great?” Essentially, the withholding benefit allows companies to monetize the credit. To illustrate, rather than remitting withholding payments to the state each payroll cycle, the company uses the credit against the withholding amount and keeps the “cash” instead. For further benefit, the credit doesn’t expire, and it can be used each payroll cycle until all of the credit has been utilized, resulting in some companies’ “eliminating” the state payroll tax withholding payment for the entire year.
The state R&D credit is often overlooked, but shouldn’t be ignored. The varying state credits should be considered if looking to relocate a company or if an expansion is planned. In some states, even a move to a different county within the same state could result in a difference in state R&D credit available. A R&D specialist will be able to assist with any necessary state credit comparisons for your business.
Activities that qualify
There is a misconception that manufacturing companies are stagnant. However, the fact is that the majority of manufacturing companies are continually innovating new products, improving existing products and developing new manufacturing processes. From a product standpoint, activities undertaken to develop new product offerings qualify for the R&D credit. Similarly, activities revolving around iterative changes to existing products that enhance performance, reliability or quality also qualify for the R&D credit.
Manufacturing companies are also eligible for credit for activities relating to creating new and or improving existing manufacturing processes. In order to remain competitive in the market, companies are researching and developing ways to produce their products faster, with better quality and for less money. This can include automating processes, eliminating waste, recycling of waste material, increasing throughput and many others.
Unless your company, for at least the last 10 years, manufactures the same product, the same way, it is likely there are R&D activities taking place.
What manufacturing companies need to do to take advantage of this opportunity
Documentation is key in substantiating any R&D credit claim. This includes documentation regarding the activities taken place, those involved and to what extent, as well as any costs incurred during the research process, such as supplies or contractors. Far too many taxpayers rely on non-specialist preparers to calculate the R&D credit, often resulting in an audit risk for overstating the credit or leaving opportunity on the table by understating it, as well as not preparing the documentation required to substantiate the credit.
The best solution is to have a R&D tax credit specialist assist you in calculating and substantiating your credit.
Betsi Barrett is a partner in the Credits and Incentives practice of Bennett Thrasher LLP, a comprehensive tax, accounting, assurance and consulting services firm in Atlanta, Georgia.