R&D Tax Credit: A Possible Solution for Increasing Cash Flow
by Matthew Nistler, CPA
After months of lockdown, the economy is slowly coming back to life, eliciting sighs of reliefs from business owners nationwide. Nevertheless, businesses are still grappling with uncertainty. Many are wondering how they can hit pre-pandemic revenue levels and generate cash flow.
For some businesses, the research and development (R&D) tax credit could be part of the solution. Here’s what you should know about it.
What is the R&D tax credit?
Generally speaking, the R&D tax credit rewards taxpayers that engage in qualified research activities (QRAs). These could include designing, developing, or improving products, processes, techniques, software, or formulas. To be considered a QRA, an activity must pass each part of a four-part test found in Section 41 of the Internal Revenue Code.
The credit allows business owners to recoup current and previous years’ (up to three years) expenses for ongoing and completed R&D activities. It’s a dollar-for-dollar offset against taxes owned or paid that delivers an immediate cash tax savings.
You don’t have to conduct R&D to qualify.
All too often, we see business owners brush aside the credit. They assume they won’t qualify because they equate conducting R&D with wearing lab coats. But here’s the thing: Things you do as part of your normal business operations could count as QRAs. These could include making small tweaks to a product to increase sales, restructuring a process to make it more efficient, or creating a prototype. Developing formulas for chemical processes or developing software to increase efficiency could be QRAs, too.
In other words, you could get a tax credit—one that has the potential to drive cash flow—for activities you’re already doing.
The R&D tax credit is not limited to certain industries.
Any business that has a tax liability could potentially qualify for the R&D tax credit. Prime candidates include businesses in the manufacturing, professional services, and construction industries. We’ve even known mortgage companies that have qualified. Some of the engineering firms we work with have qualified because of the design and CAD work they do to come up with new models.
For start-up businesses that don’t have income tax, the R&D credit can be applied against payroll tax. Applying for the credit involves filing certain forms with your federal income tax return.
How do you know if your business qualifies?
Determining if you qualify for the R&D credit can be tricky. It can be hard to follow the four-part test and what’s needed for documentation. To help you assess your ability to qualify and potential benefits, we offer a complimentary initial R&D credit assessment. This allows you to know right away if applying for the credit is worth your time and effort. We’re also here to help you understand which activities you should be tracking and documenting to qualify.
Generate cash in the short term.
If you were to qualify for the R&D credit, you could potentially reduce your tax liability or carry credits forward, giving you an immediate cash tax savings. Again, the credit can be applied to your tax liability for up to three years back.
If you have questions about how the R&D credit could help your business weather the COVID-19 storm, contact us today.
Looking for more?
Check out more R&D, tax, and business-related resources from Abdo.