It’s been more than a year since the Protecting Americans from Tax Hikes Act of 2015 (PATH Act) made the Research Tax Credit (RTC) permanent. Since then, businesses of all sizes have been factoring the RTC’s benefit into their financial planning, generally adding to their bottom line about 10 percent of their wage, contractor, and supply expenses for attempts to develop or improve products, processes, or software.
Moreover, even more small businesses and startups have begun to take advantage of the RTC, as the PATH Act enables them to use the credit against their payroll or alternative minimum tax (AMT) liability for the first time. Savvy companies are grabbing these benefits now by reviewing their investments to see if they qualify.
Who’s Claiming RTCs?
In 2013, the IRS estimated that 16,624 C corporations claimed $11.3 billion in federal RTCs. The number of claimants in 2013 represents a 5 percent increase over 2012’s 15,873 and a 60 percent increase over 2003’s 10,369.
Notwithstanding these increases in claimants, though, many businesses eligible for the RTC aren’t claiming it. According to BDO’s 2017 Tax Outlook Survey of US tax executives, of the 87 percent of respondents who are familiar with the RTC, a full 18 percent aren’t claiming it.
Their reasons include:
As the graph shows, half aren’t claiming the credit because they believe they’re not doing “groundbreaking” work, 18 percent are concerned about audit-related issues, and 13 percent think they’re either too small to benefit, wouldn’t be able to use the credit because they’re paying only AMT, or lack necessary documentation.
None of these reasons precludes claiming the credit, and typically all of them can be addressed:
- Work doesn’t have to be groundbreaking to qualify; in fact, work that doesn’t work typically makes supporting its qualification even easier than if the work succeeded.
- Tax examiners may audit RTCs, to be sure, but if the credits are identified properly, they can be supported by not just documentation but oral testimony as well.
- The size of a company isn’t directly relevant to the size of the RTC’s benefit: Many companies with no sales at all generate significant RTCs. They can use these credits now or carry them back one year or forward for 20.
- Similarly, if a taxpayer is paying AMT, it can carry the credit back one or forward 20. If the taxpayer is privately held and has $50 million or less in average annual gross receipts for the prior three taxable years, it can use the RTC to offset its AMT for 2016.
- And as mentioned and upheld by various court decisions, including by the US Tax Court, RTCs may be supported by not just documentation but also oral testimony.
Who Should Be Considering Claiming RTCs?
In general, any active trade or business that pays for activities in the United States that meets these criteria:
1. Permitted purpose. The taxpayer invests in an activity to improve the functionality, performance, reliability, or quality of a product, process, software, technique, invention, or formula to be used in its business or held for sale, lease, or license (component).
2. Uncertainty. The taxpayer encounters uncertainty regarding whether it can or how it should develop or improve the component, or the component’s appropriate design.
3. Process of experimentation. The taxpayer attempts to eliminate the uncertainty by evaluating one or more alternatives through modeling, simulation, systematic trial and error, or other methods.
4. Technological in nature. The success or failure of the evaluation depends on the principles of engineering, physics, chemistry, biology, computer science, or another “hard” science, not those of marketing or economics, for example.
Companies in virtually every industry and of every size claim RTCs. For example, local craft beer breweries with sales under $1 million claim RTCs for their efforts to develop new recipes, improved hopping or fermentation techniques, and the like. More generally, most manufacturers, whatever their size, that try to make things better, faster, cheaper, or greener are performing at least some qualified activity.
As mentioned above, many aren’t claiming RTCs for all their qualified work. For example, according to BDO’s 2017 MPI Internet-of-Things Study, more than 62 percent of respondents don’t plan to claim RTCs for their investments to leverage the IoT. Many of these investments, though, often involve qualified activities because they involve attempting to design, develop, and/or incorporate sensors, transmitters, smart devices, or other kind of machine intelligence into their products and plants.
Small Businesses: Have You Marked Your Calendar to Claim the Payroll Tax Offset?
Companies that pay for qualified activities may elect in 2016 to use up to $250,000 of their annual RTC against their portion of payroll (FICA) taxes provided they have:
- Gross receipts less than $5 million in the tax credit year.
- No gross receipts for any tax year before the five taxable years ending with the tax credit year.
The payroll tax offset is available quarterly beginning in the first calendar quarter after a taxpayer files its federal income tax return. Companies planning to file their 2016 federal income tax returns by June 30, 2017, therefore, can take advantage of the offset in the third quarter of this calendar year. This election may be made for 2016 and the four following taxable years.
Don’t Delay – Claim Your Credit
Regardless of the size of your organization or the nature of your industry, if your business qualifies for the RTC, it makes sense to pursue it now: Not only will you benefit now, you’ll position yourself to do so more easily in the future. Starting now to build RTC savings into your fiscal future will also help protect these savings during an examination by tax authorities, who prefer claims be identified during or shortly after the year that gives rise to them, as opposed to later years.
So if you meet the criteria above, join the thousands of companies benefiting from the RTC and consult with a tax advisor who specializes in the RTC area to claim it today.