Yes. Start ups, even when they are recording losses, can take the credit. In most cases, companies will choose not to simply because they won’t be able to utilize these credits for extended periods of time based on how much in losses they have to carry forward. However, it is beneficial for companies in loss positions to conduct a R&D credit study to ensure that they don’t lose out on any years because of the statute. Some companies with this fact pattern will engage an R&D tax credit consultant at a lower fee by leveraging their inability to utilize the credit as a way to drive down the upfront cost. They will repeat this process every 3 years so they don’t miss out on any credit opportunities, then just carry the credits forward until they see some tax liability.
Can Startups take advantage of the R&D tax credit?
If your CPA has not identified the R&D Tax Credit as a benefit that fits your company’s fact pattern, it isn’t an indication that they failed you. In actuality, it is more of an indication as to the complexity of the tax code. There are thousands of regulations, programs and processes outlined in the federal tax code and no CPA can be expected to know 100% of all these issues. This is why we always recommend you engage a specialist for the credits you are interested in generating.
Why hasn’t my CPA told me about the R&D credit?
Unlike a tax deduction, an R&D tax credit is a dollar-for-dollar credit; this reduces a taxpayer’s bill by a full dollar for each credit dollar. A six-figure tax credit increases Earnings After Tax by the full amount of the credit. A tax credit that can be used to reduce the taxes to be paid means that much more cash in the company’s bank account.
How does the Research and Development tax credit help with cash flow and profits?
No, it’s not a refundable credit. This means that if the credit is in excess of the tax liability, you cannot get a refund greater than the amount of the tax that is owed. For example, if your tax credit is $25,000 and your tax liability is only $18,000, then you will receive a credit (refund) of only $18,000. The unused tax credits rollover and can be used in future years (up to 20 years for federal purposes).
Is this a refundable credit?
While not always 100% accurate, there are ways to estimate the amount of credit you might be able to generate with minimal information. The biggest indicator of how much credit a company can generate is usually the total payroll for all the employees. Based on the industry, anywhere between 5% to 80% of the expenses can be qualified. This involves determining how many people get involved with product and/or process improvements/developments and to what extent they perform development or improvement activities. Once you have a general idea of how much of the payroll you would like to qualify, you can estimate the federal credit by taking 6% of that number. While this process will allow you to estimate the amount of credit, this is not a guarantee of a benefit. The final form of the calculation, depending on what method you would like to utilize, will take into account past R&D spending to determine the level of credit.
How do you determine how much credit can be generated?
As straight forward as this question sounds, it is actually a pretty complex issue. The reason why this is complex is because the calculation for the credit was designed to fit companies of all sizes to compare relative spending year-to-year. For instance, a software development firm might have only 10 people, but all could qualify at a high percentage of time and have high compensation which would be a very favorable fact pattern that maximizes credit yield. Conversely, a manufacturing firm with over 1,000 employees might be qualifying a lot more individuals, but because their average wages a relatively lower than our first example analysis can show that the credit could be much smaller even though the number of qualified employees could be several times more.
How big does a company have to be to generate a credit?
Yes. As long as the design and development work is done here in the US, manufacturing of this product can occur anywhere, whether the manufacturing is outsourced or the manufacturing company is your own.
Can I claim the R&D tax credit even if all of my manufacturing is done overseas?
You can go back to any open tax year, which typically is the prior three years for Federal purposes and four years for California. For example, if you have a December 31 year-end and you filed your 2010 tax return on March 15, 2011, your 2010 tax return is open until March 15, 2013.
How many years do I have to claim the credit?
Every project that is qualified and generates Qualifying Research Expenses (QREs) needs to meet all parts of the 4 Part Test.
Permitted Purpose – The project must result in a new or improved process, function, product, performance, reliability, quality or significant reduction in cost.
Elimination of Uncertainty – Every project must have a documented uncertainty that pertains to specific criteria being addressed by the project.
Technical in Nature – The project must rely on fundamentals of engineering, physical or biological science, or computer science.
Process of Experimentation – The project must involve an iterative method of developing hypotheses, testing these hypotheses, and validating them.
How do I know if my R&D project qualifies for the credit?
The simple answer is no. While the credit does not require that a taxpayer establish and maintain a contemporary time tracking system, it is important to ensure that documentation on the work being performed is being recorded regularly. If documentation of actual activities, issues, alternatives, etc. is kept, then qualifying time can be provided by Subject Matter Experts (SMEs) that have intimate knowledge about a particular project or activity. However, having a time tracking system allows for much more visibility both while the analysis is being conducted and in an audit situation at a later date.
Does the credit require a time tracking system?
The short answer is 3 years, but as with all tax matters, the real answer is much more complex than that. For all intents and purposes, a taxpayer has 3 years to complete their analysis and file a credit. This is because the IRS regulations allow you to conduct retroactive studies up to 3 years after you filed that year’s return. So if you were on extension in 2012 and filed in September, you would theoretically be able to conduct your analysis and file by September of 2015 and still gain some benefit through the credit. Some states allow you more wiggle room in terms of claiming the credit. For instance, in California, the deadline for a retroactive study and amendment is 4 years as opposed to 3. However, this varies from state to state.
There are several problems with filing late and those concerns don’t revolve around the statute. For instance, if you decided to file your credit form for a year that has already closed, you would need to amend your return which would incur additional costs if you don’t have an in-house CPA. In addition, if you choose to conduct your analysis at a later date, the chance that a key employee that needed to be interviewed could have left or simply, cannot remember the details of the activities they conducted several years earlier becomes higher as time passes.
It is always our recommendation that companies, if they have tax liability that can be offset, that companies do not wait to file their R&D credit forms until the last minute.
How long do I have to file the credit?