Debunking 7 Common Misconceptions Around the R&D Credit
ATS, we work with companies in every industry in all states to help them claim R&D Tax Credits. While this tax credit has become more popular in recent years, there are many misconceptions that are commonly held. This article will dissect some of the most common misconceptions we see when working with companies.
My company does not do R&D in the traditional sense
When you talk to most people about research and development they think of lab coats, microscopes and scientific experiments. While these types of activities are definitely eligible, the definition of R&D for the tax credit is much more inclusive. Any company in any industry can claim R&D Credits as long as they meet certain criteria. Mainly if you are using trial and error or some form of the scientific method to develop or improve a product, process, or design, you may be eligible. Typical activities include:
- Software development
- Product development
- Architecture and Engineering
- Manufacturing automation
- Systems engineering
My company doesn’t have any income tax, so the credit does not benefit us.
Many companies that have an operating loss and thus don’t generate income tax think that there is no benefit in this credit. In fact, there are generous allowances for qualified startup companies that allow them to use this credit to offset payroll taxes. If your firm has less than five years of revenue and makes less than $5 million per year, you can use R&D Credits to immediately offset the employer portion of payroll taxes on you next quarter’s filing. For other companies, any unused credits can be carried forward for 20 years. Claiming a tax credit in an unprofitable years is beneficial for future years where taxes will be owed on profits. Additionally, deferred tax credits can increase the value of the firm.
My company does not book R&D expenses and does not have a time tracking system. We can’t claim the credit
Tax Courts have rules multiple times that a company is not required to use time tracking to claim R&D credits. While any tax credit claim must be backed up by documents showing that R&D actually occurred (emails, project notes, notebooks, etc.), you are not unable to take the credit just because your employees don’t use time tracking. There are many ways to develop a reasonable construction for how much time and money a company has allocated to R&D. The fact is many small businesses don’t use time tracking. This does not prevent them from obtaining this benefit. If you actually took the risk and performed R&D, this incentive is for you!
Claiming R&D Credits will generate an IRS audit
This is simply not true. While the IRS can challenge any claim made on a return and does have R&D Credit specialists, audit rates of R&D Credit claims remain relatively low. It is very rare for us to see the IRS challenge tax credits under $60k. If they do, the ATS team is experienced in defending these credits under audit and with IRS appeals.
The process of claiming the credit will be too time consuming
This depends on who you work with. Some R&D Credit providers (especially anyone marketing a software that claims R&D credits for you) will require the business owner or CPA to do a lot of the manual work. At ATS we try to make the R&D credit process as seamless as possible, requiring no more than a few hours’ time from various employees. Make no mistake, R&D Credits do require through due diligence. But our expertise allows us to take most of the burden of finding and documenting R&D expenses.
Claiming R&D Credits is not worth the fee
In the world of R&D Credit consulting, many providers charge a percentage of tax credit savings (sometimes between 25% and 35%). The IRS does not like this model of charging “contingency fees” and is moving to crack down on it (especially in the wake of Employee Retention Credit schemes). Many firms will try to hide that they are charging a % of savings by saying that they charge hourly not to exceed 25% or 33% of the credit. Somehow, their hours always reach the max!
It doesn’t have to be this way. ATS works on a fixed-fee basis just like any other tax provider and our clients usually realize a much better return on investment than the larger firms.
My firm and my CPA can handle the claim ourselves
When some firms see the fee discussed above, their natural conclusion is to prepare an R&D Credit themselves. If this is you, proceed with extreme caution. There are dozens of tax court cases surrounding what can and can’t be claimed as R&D complimented by hundreds of lines of tax code and federal regulation. Not to mention all of the IRS internal manuals discussing what they look for in an audit. There are no black and white rules for applying the R&D Credit. It required a nuanced understanding of how to apply all of the relevant authority to a business case. Now more than ever, claiming R&D Credits requires expertise in this niche area. If you do not use someone who has spent years working in this field you run the risk of making an error on the tax return or failing to withstand IRS scrutiny.
As we stated above, claiming the R&D Credit doesn’t have to be hard or expensive. Contact the experts at ATS today for a free analysis of how the R&D Credit can benefit your company.