The ABCs of the R&D Tax Credit
Here’s what you need to know to see if you qualify for this often lucrative tax credit. Chances are, if you build complex molds, you are entitled to reap the benefits.
The R&D tax credit is not widely known to small and mid-size mold manufacturers. And—even if the shops’ accounting firm or CPA may have heard of it—they may not be able to provide proper advice regarding this very specialized area of the tax code. However, if a shop qualifies (see What Constitutes R&D Sidebar), it can be beneficial to business. Currently, the U.S. government is attempting to provide incentives for companies to invest back in their businesses, hire employees, and improve the underlying technology in their business so that industries in the U.S. can stay competitive globally. That is really why this credit exists.
Basically, the R&D tax credit is just that—research and development for tax credit purposes. If a shop is engaged in activities that are developing or improving products, or developing and improving processes, R&D is probably being conducted. While these terms are fairly broad, enlisting help from a tax firm that specializes in the R&D tax credit can help a shop determine if it can generate this tax credit.
It is important to differentiate between a tax credit and a tax deduction. A tax credit is worth more to a shop than a tax deduction. Tax deductions are worth whatever a shop’s tax rate is, and a tax credit is a dollar-per-dollar reduction off of a shop’s tax liability. The key thing is you don’t have to decide whether to deduct or generate a credit—it’s both.
To determine the potential size of a shop’s tax credit, one can look to the prior open tax years, which are usually the three prior years as a rule of thumb, in addition to the current tax year, and tax credits can potentially be generated for all years. To the extent that the company was profitable and a taxpayer, or in the event the shareholders of an S corp. or LLC were tax payers, it may be possible to amend those prior tax years and get a lot of money back.
While this is potentially a great opportunity, it can be complicated. Here is what to look for in a firm that specializes in the R&D tax credit.
A company that focuses firmly on the R&D tax credit will be able to best help moldmakers as it is a generally gray area and can be very subjective. Make sure the firm is well versed on the subject and doesn’t just dabble in it a few times a year. The company may be able to help generate substantial amounts of cash from prior years when perhaps the moldmaker didn’t take advantage of the R&D tax credit. In addition, this firm should educate and raise awareness around the opportunity so that moldmakers can effectively use the tax credit on a go-forward basis, which means reducing future tax liabilities and improving cash flow.
Find a company that will honestly tell you if it is worthwhile to pursue this credit. For example, some R&D Tax Credit firms don’t get involved unless a company can generate a minimum of $80,000 to 100,000 of cash over a three- or four-year period (this includes the current year and the prior two or three).
The firm you choose should immediately open up the lines of communication. Normally, a tax credit firm would set up a conference call or meeting upon initial contact; and in that initial session introduce the moldmaker to the rules for R&D tax credit qualification, talk about the business and the people within the company, try to identify what activities may fall within that R&D tax credit rules and provide the mold shop with a potential estimate of what size of a credit the company may be generating.
At the end of the initial call, the moldmaker should get a sense of whether the R&D Tax Credit may be a good opportunity for the company. If it is decided upon that it is a worthwhile activity and the moldmaker wants to move forward, the tax credit firm can begin to assist the moldmaker in documenting the necessary information to generate the credit.
The next step is for the firm to visit the moldmaker in order to talk to people within the company about the definition of research and development, what their daily activities are and how employees are spending their time. It is through this education that the tax firm can help the moldmaker accumulate all of their costs associated with R&D activities. The firm learns what types of projects the moldmaker has been working on and obtains more details in those areas. In that planning phase, the tax firm should examine the moldmaker’s tax return and payroll information. Normally it is readily available information and it is not necessary for the moldmaker to create a project tracking system.
From all of these conversations, the firm can create a supporting binder, which will contain the quantitative part of the analysis, including the calculations as well as the input for the calculations, and write-ups of all of the activities and costs that are considered “Qualified Research Expenditures” (QREs). It can take an average of four to six weeks for an R&D Tax Credit firm to complete the onsite visit, organize and document the data, and get the “Final Deliverable” back to the company. Then, the tax firm will work with the company’s CPA firm to help them file amended returns or to figure out how to best use those credits.
Return on Investment
The R&D tax credit firm the moldmaker chooses should have the moldmaker’s best interests in mind to ensure there is a good ROI. Just because a shop can generate a tax credit doesn’t mean it can use one.
Make sure that a) a “meaningful” tax credit can be generated, and b) it can be used immediately to generate cash or reduce a current tax liability—as it’s not always a given it is usable. For example, if a shop has struggled in the past and hasn’t paid taxes, tax credits cannot be used. A company cannot ask for a tax refund if no taxes have been paid. In addition, shareholders who are/have been impacted by the Alternative Minimum Tax (AMT) also may not be able to use tax credits.
A good ROI also is dependent upon having enough money left over after the shop has paid its CPA firm, as well as the R&D tax credit firm. Some tax credit firms provide different payment options: a success fee or percentage of tax credits identified, or a fixed fee. It really depends on what the client’s comfort level is.
Finally, it is important to note that the moldmaker doesn’t have to use all of the tax credit at once. Any unused Federal R&D tax credits can be carried forward for up to 20 years. In addition, numerous states also have a state R&D tax credit that can potentially increase the size of a company’s benefit. A reliable R&D tax credit firm will work with a moldmaker to effectively identify all opportunities to take full advantage of the credit.
As with most matters related to running a shop, education is critical. Seek out the most expert assistance available, and your shop can reap the benefits of this lucrative opportunity.
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