Competition is a global dynamic as well as a local fight. As small business owners keep their heads down to out-perform the business across the street, they have to be wary of competitors across the country and, today, across the world. In many cases, it isn’t a fair fight and while we might argue American pride, innovation and work ethic, when the labor pool and tax environment are tipped in favor of the competitor, it’s tough to win, even when you fight the good fight. Research and development tax credits are just one of many tax incentives available to US businesses to help them stay more competitive in this changing global market and while a significant amount of these credits are taken by large corporations, small businesses can and should take advantage of them as well.
Think INNOVATION and PRODUCT DEVELOPMENT
The federal R&D tax credit isn’t about developing something ground breaking or earth shattering (although those types of activities should qualify as well). The research credit is about innovation and staying competitive; at its core, it is a jobs credit designed to incentivize companies to hire more people. Examples of activities that should qualify include:
- A contract manufacturer develops a new type of machine for a customer;
- A bakery formulates a new high protein or low-carb bread;
- A software developer completes development on a new application for the iPhone or Droid;
- A capital equipment manufacture develops a new process for the solar panel industry that improves solar panels;
- A machine shop redesigns a manufacturing process to cut, bend and fashion a highly complex part with over 1,000 different cuts;
- A medical device manufacture designs a new testing methodology to analyze test tube contents without disturbing the actual samples inside;
- An auto manufacturer redesigns the chassis of a trailer, creating a longer and more stable movable side panel;
- An instrument company launches a new line of products utilizing new materials making their products stronger, lighter and more durable.
These examples of innovation and product development are examples of activities that should qualify for federal research and development tax credits.
These are activities that, in many cases, go as missed opportunities because the business owner doesn’t realize his sweat equity and solutions can qualify for tax credits.
Think AMT?-Not an issue for small businesses
As long as the R&D tax credit has been a part of the US tax code, it has been effective at reducing the regular taxes of those who utilize it. However, until the recent small business tax act passed by Congress and signed by President Obama, you could not use the R&D tax credit to reduce alternative minimum tax (AMT). Beginning in 2010, credits listed under Section 38 of the US tax code can now offset AMT. This includes the R&D tax credit as well as many other tax credits. This is a significant break for small businesses that are often unable to use the R&D credit to any real benefit. Going forward, small businesses can reap the benefits and reduce their overall tax burden and not just regular tax.
One of the biggest questions and challenges we hear from our clients is how and what to document. It’s no surprise that the IRS focuses on the available documentation (rather than the qualifying activities) and how and when it was developed.
The courts have gone from allowing substantial leeway in the types of documentation to a hard line expectation of contemporaneous documentation to moving to a more reasonable position allowing some estimates where the base assumptions can be established as reasonable. It is safe to say that companies should develop a system that provides for the accumulation of the proper information on a timely basis rather than trying to look back and develop it at a later date.
When working with small businesses, we look at their internal processes to develop a system that provides the necessary information and at the same time doesn’t add significant time to the process. In some cases, the amount and type of information collected can be used for other purposes such as budgeting, program or project management or continuous improvement.
Think SMALL BUSINESS
R&D tax credits today can make an impact on a small business’ bottom line and ability to grow. Coupled with the available state tax incentives that dovetail the federal research credit, the benefit to a small business can range between 6% (taking only the federal research credit) and more than 18% depending on the location of the company. In addition, many state research credits are already permanent (unlike the federal research credit that is temporary and requires Congress to renew it annually or every couple years). Considering this impact, the renewal of the R&D tax credit is an imperative for many small businesses that are aware of its benefits. For those companies that are either unaware of it or are not sure if it impacts them, they are missing a significant component to their business plan and overall success strategy.
About the Author
Randy Eickhoff, CPA is President of Acena Consulting, LLC (www.acenaconsulting.com), a specialty tax consulting firm focused on helping CPAs and small businesses understand and maximize the benefit of US tax incentives.