Companies that engage in the acts of making/creating something new or vastly improved (products and/or production processes) may be entitled to substantial Tax Credits. Companies that typically qualify are engaged in some aspects of manufacturing, high-tech, software-development, chemical processing, food processing and/or energy/green related efforts.
The rules and regulations were changed to provide stronger incentives to small and mid-sized firms who were finding it hard to compete with jobs and skilled labor moving overseas. Not only does the credit count against current tax year liabilities but the law allows for a company that has never taken the credit to go back to three additional years to capture credits due them. These credits apply dollar for dollar against the bottom line taxes and can come back as refunds to the extent that taxes were paid. Excess credits over the amount of taxes paid can be carried forward (up to 20 years) and applied against future tax liabilities (also to reduce estimated quarterly tax payments).
In addition to the Federal Credit, many states offer a state R&D version as well. In most cases they have adopted the federal definitions guidelines but may vary in how they calculate or set certain limits on how much may be paid out. In most cases the state versions come close to the Federal which makes the total credit amount potentially quite appealing.
This webinar will address a) the specifics of qualifying, b) the requirements for reporting and providing support for said claims, c) present details surrounding certain court cases that provided more favorable reporting capabilities to the taxpayer and d) cover audit triggers and defenses pertaining to R&D. Billions of dollars have been paid out in credit claims over the past years yet there are still thousands of companies who a) do not know about the credit, b) know of the credit but do not believe that they qualify and/or c) have fears about the process that keep them from capturing significant dollars due to them.
Follow-up questions answered by Steve Ragow
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Do Statistics and Advanced Mathematics meet the requirement “Technological In Nature”?
Yes. Obviously there are other parts to the “Test” for qualification but in terms of meeting the requirement that the new/improved product or process is technological in nature would be met if the work product involved the utilization of Statistics and/or Advance Mathematics.
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What Is The View Of The Company Owner Participating In The R&D?
In most small to mid-sized corporations the driving force for R&D – and a heavy participant in the planning, design and review efforts (if not more) – is the company owner/founder. The challenge is not in establishing his/her participation but in proving the extent of involvement. The IRS position up front would be that the owner has a company to run and is involved in administrative efforts and his/her involvement in R&D is minimal. It is typical to see standard allocations of 20 to 30% of an owner’s time assigned to the R&D efforts. If there is more – and there usually is with smaller operations – then significant documentation will be needed to back that up (e-mails, meeting notes, etc.)
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What Income Is Included In The Wage Portion Of The Calculation?
Usually it is Box 1 of the W-2 wage for the year (annual bonuses are included which may entail a separate form).
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What If The Owner Does Not Receive A W-2?
One owner LLC’s may not create a W-2 – they just take income as needed and the P&L reflects the flow thru profits to the owner. In most cases the flow thru profit would count as income (there might be some cases where a lesser number might be used).
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If A Shareholder With A $1 Million Income Claimed 80% Towards R&D Participation – Can That Be Sustained?
The amount of income is not limited nor the percent that an individual works on R&D. The requirement is to establish enough documented proof in support of the percent of time worked on qualified research activities. If the percent can be supported then it is applied to the income – with no upward limit on amount of income.
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Are There Case Laws Relative To The Question In Point Five Above?
No. There has never been a challenge by the IRS on this issue. The regulations are very clear on how to define qualified projects and tasks – how to measure a person spending time on qualified activities within these qualified tasks – and how to determine the percent (Note: Under IRS definition – a person spending 80% or more of their time on qualified activities is to be treated as 100% allocated – thus, in response to #5 above all $1 million dollars would go into the credit calculation pool). There have been projects worked on where owners and/or senior level people were heavily allocated to R&D with wages ranging from $700 – 800,000 to $2 – 3 million and the burden of proof was just related to establishing the amount of work they performed.
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What Is The Risk Of Audit?
There is always the potential for a “Random Selection Audit” or for the IRS/FTB to conduct an audit for some reason not related to R&D but, since an audit is incurred, the R&D most likely will be pulled into the pile for review. In the case of the R&D itself triggering an audit – this is not an automatic issue. The Credit is a viable and real credit (the IRS has paid out billions over the past few years) written up in the Tax Code. The Credit has become an item subject to scrutiny because of many incorrect calculations and assumptions made on numbers and work effort that cannot be substantiated. If the company having a study done has done the due diligence in selecting a provider that can establish it is knowledgeable of current regulations and court case law, knows the required methodology in documenting the credit data for review and has a stop gap method in place where after some short review period – they discuss with owner and CPA all known factors such as credit amount, utilization capability and potential issues to support claim or portions of claim – then the company will most likely be moving ahead with a claim that is best supported if it comes under audit review.The fact that an audit may occur does not mean that the R&D credit is not valid…it just means the taxing authority may have questions about the validity of some items and many times this goes away after a short Q&A discussion between the taxing authority and the service provider.
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What Credit Values Can Be Expected?
There is no automatic method of saying immediately what one may get back on a R&D claim. A review of tax returns along with applying certain industry standards to a model can determine a potential range of credit. However, until some preliminary evaluation is performed – there is no way to determine actual amounts available that can be supported. In the past there have been credit returns as low as $25,000 and as high as multiple millions. It is not uncommon to expect some six figure credit potential where the state that business is performed in also offers a state R&D credit in conjunction with the Federal credit.
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What If All The Credit Cannot Be Utilized Now?
Credits applied for under past years (amended returns) will result in a refund up to the extent that taxes were actually paid in. Unused credits can be used to offset taxes due in the current year (also to reduce estimated tax payments). Where remaining credits still exist after the above is exhausted, they can be carried forward for a period of up to 20 years and used accordingly each year.
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Explain The Change In Law Relative To “Alternative Minimum Tax”
Up thru the end of 2009 there was the concept of Alternative Minimum Tax (AMT) – the guaranteed minimum tax that one had to pay no matter what. Tax Credits could not penetrate the AMT levels – thus is a person faced an AMT of $90,000 and had a $100,000 Tax credit, they would only be able to get the benefit of $10,000 and had to carry forward the rest. With AMT continuing every year this made the concept of applying for the credit unfeasible.In 2010 the AMT limitation was rescinded. Thus, a person who faced a $90,000 AMT and had a $100,000 tax credit would be able to wipe out their tax liability and carry $10,000 either into the next year OR to go back to prior years and penetrate earlier AMT levels with current excess credits and get more refunds.
