R&D tax credits aren't only for big corporations employing lab coat-clad scientists tinkering with test tubes.Yet scads of small- and medium-sized businesses — from architectural firms to wineries — fail to take advantage of tax credits for research and development. In many cases, the owners don't realize they're eligible, or they believe it's not worth the hassle and time to figure out the complexities of the tax code only to attract scrutiny from the Internal Revenue Service.“We help hundreds of companies, and the biggest problem is they don't know how broad the tax credit is,” says Dean Zerbe, national managing director of Texas-based tax incentives consulting firm alliantgroup. “Unless you're continuing to make the exact same widget in the exact same way every year, you're doing R&D.”
Hurdles And Payoffs
Besides figuring out whether they're eligible, companies also must come up with the right documentation for the IRS.
“You can't put it on the back of an envelope and empty out a shoe box to get it,” says Zerbe. “It's an extremely complicated area of law and very complicated to qualify.”
Companies must substantiate all expenses for R&D projects. The claims must meet the government's "threshold of innovation" and be in compliance with the tax code, Treasury regulations and guidance from the IRS.
While big companies often rely on their in-house teams of accountants and tax experts, smaller companies typically have to hire consulting firms that specialize in R&D tax credits to do the research and write the reports showing they qualify.
“When we initially looked, it was beyond the scope of our accountant's expertise,” says Geoff Flint, founder and chief executive of CustomWeather, a San Francisco-based company that provides syndicated content for global weather coverage. “It's not just the accounting side of it. You also have to know the technology side of it, as well.”
After hiring alliantgroup, the company was able to go back and recoup about $300,000 for five years' worth of federal and state R&D tax credits for the innovative software its team of meteorologists and programmers developed for weather forecasting.
“It's worthwhile for a company that employs eight people,” says Flint. “In a high-tax state like California, it makes a big difference.”
Federal R&D tax credits — among the biggest tax breaks for American businesses — were introduced in 1981 in a bid to fix the country's lagging competitiveness. Although never made permanent, the credit has been extended more than a dozen times over the past three decades and enjoys bipartisan support.
The federal government is expected to disperse more than $400 billion on R&D this year, with states adding billions more.
Qualifications for such tax credits used to be a lot more narrowly defined than they are today. The new standard is much broader, so that, instead of coming up with an invention or winning a globally recognized patent, for example, a company simply must prove it's developing something new and improved for itself as a company.
Wineries, beer makers, furniture and cabinetmakers, job shops, waste managers, farmers, apparel makers, packaged good designers, green building designers and a long, long list of others are potential qualifiers for the tax break.
Size does matter. [Most experts agree that] for a company with less than a million dollars in annual revenue it's typically not worth the effort given the complexity of the code and burden of proof required.
For small businesses that are big enough, the R&D tax credit can be a nice boost, especially if they're based in one of the more than three dozen states that also offer credits for research and development.
New Orleans-based Smoothie King, a pioneering drink chain with $10 million to $12 million in annual revenue, is among those beneficiaries.
“We became aware of the credits when a local CPA firm put us in touch with the alliantgroup,” says Joel Meariman, chief financial officer of Smoothie King, which employs 60 people. “The process has been fairly simple and painless.”