The research and development tax program allows business owners in a wide industry range to offset tax burden for qualifying operational activities. Offering both state and local program components, the R&D tax credit delivers an outstanding cash flow opportunity for companies of every size and in every vertical.
Despite the plan's significant potential benefits, countless eligible businesses in multiple fields still miss out on the capital offered through the innovation tax credit initiative. Some organizations fail to tap into the plan's advantages simply because they don't know the program exists, while others struggle to discern the legislative nuance in the ever-changing tax terrain. However, some entrepreneurs have all the details about the program they need, yet still fail to tap into the savings power of the R&D tax credit due to their concern of being audited.
Yes, the mere mention of the word "audit" can trigger a flash of (understandable) worry in most business owners. However, you shouldn't let fear of a future audit prevent you from leveraging this robust and lucrative incentive to minimize your company's tax burdens. Understanding some of the do's and don'ts of qualifying activities can help you operate with a steady focus on what the auditors will look for when assessing your tax claims.
Recognizing Qualifying and Non-Qualifying Activities Is Important
When establishing eligibility, many business owners start by determining qualifying research expenditures (QREs). Every compliant operation must pass a detailed, four-step assessment that includes:
- Business Component Test
- Technology Uncertainty Test
- Process-of-Experimentation Test
- Technological-in-Nature Test
Yes, it's vital to have a thorough understanding of qualifying activities to protect your business from penalization in the event of an audit. However, navigating the perpetually evolving R&D tax credit landscape is challenging for both business owners and CPAs alike, particularly when it comes to recognizing operations that don't qualify for a deduction.
Many corporate professionals don't realize they can't claim operating expenditures for activities they would perform regardless of current research and development operations. Some common misclassifications of expenses and procedures not eligible for the innovation tax credit include:
- Research practices conducted outside of the United States
- Research activities not funded by the taxpayer
- Design or development solely used for product or packing aesthetics
- Typical assessment or evaluation procedures for quality control measures
- Qualifying and evaluating product lines
- Modifications to production line processes that don't include technical uncertainty
- Promotional or advertorial market research
- Standard data collection processes
- Initiatives related to seasonal design, flavor, or style
- Management studies and surveys
- Training programs (giving or receiving)
Industry conferences and trade shows
Additionally, many business owners and financial advisors don't realize that non-qualifying activities can also extend to hiring and recruiting practices as well. For example, the salaries of engineering, programming, and technical employees may qualify for the R&D tax credit. However, any expenses related to recruiting this type of internal talent typically is not eligible for a deduction.
Protect Your Business in the Event of a Research and Development Tax Audit
The best way to ensure audit compliance with qualifying research and development activities for your small- to mid-sized business is to partner with an R&D tax credit specialist. At Acena Consulting, we offer our partners access to our experienced and diverse team of tax professionals who have the insight and expertise needed to properly identify and thoroughly document every activity for maximum credit calculation. Contact us today to schedule a consultation.