How to qualify for an R&D tax credit in 4 steps
February 6, 2007
Many manufacturers don't think that their companies qualify as researchers and developers. But with a little look into your company's everyday activities, you may find that you do conduct R&D - and possibly spend enough on R&D in a year to qualify for a tax credit.
Not a lot of people would be unhappy about finding an extra $20 bill in their pocket, even though it probably wouldn't make much of a difference in their lives.
But finding thousands or tens of thousands of dollars could make a big difference to many business owners.
Getting paid for researching ways to work more efficiently and make better products is the premise behind the R&D tax credit.
The R&D tax credit is potentially applicable to any successful company that performs activities that meet the definition of R&D. In some cases, even day-to-day operations qualify. This tax credit is in addition to tax deductions for R&D expenses, and any unused federal tax credit can be carried back one year to offset prior taxes paid and forward for up to 20 years to offset future tax payments.
In addition to the current year, you potentially can earn tax credits for prior years, usually three. If your company has been profitable and tax-paying, you may be able to receive substantial tax refunds by amending prior years' returns.
You're not alone if you don't think the activities within your company qualify for an R&D credit. But for tax purposes, the definition of R&D is broader than most people think.
While most fabricating companies don't develop their own products, many have processes associated with customer requests for parts and continuous cost reductions. Typically, R&D in the process side of a business becomes apparent when the company is trying to figure out how to make a product for a customer and still be profitable. This especially applies to companies that process many new part designs every year and have to figure out more efficient ways to manufacture these products.
Now that you understand a little about the R&D tax credit, let's see what steps are necessary to figure out if your company qualifies for one.
First, evaluate your company. Ask yourself if your company does any of the following:
If your company performs any or all of these activities, it could be ready for the next step.
Once you evaluate your company's activities, assess whether you can earn a meaningful tax credit by considering your R&D expenditures. They include:
Generally, wages paid to the personnel performing R&D make up the largest amount of R&D expenditures.
Once you've calculated the costs involved in your company's R&D, it's time to move on to the third step.
What's valuable to one company may be meaningless to another company. You must determine if your R&D activities would produce a meaningful tax credit. Companies with revenues of as little as $2 million to $3 million may be able to generate a meaningful tax credit.
Most specialists can help you with this step by assessing your ability to earn an R&D tax credit and provide you with an estimate so you can decide whether it's meaningful for your company. Many of these specialists will provide this initial evaluation at no cost.
Even if you determine your R&D activities won't result in a meaningful tax credit for prior years, you still can use the R&D expenditures you identified to reduce your current-year tax payments.
Once you have determined that your R&D activities would yield a meaningful tax credit, you're ready to move on to the fourth step.
Now you need to fill out the tax credit form, calculate your credit, and, if appropriate, amend your prior tax returns to claim credits from years past. The form, Form 6765—Credit for Increasing Research Activities—is filed with your tax return or your amended tax return.
To apply for the R&D tax credit effectively, it's critical that you work with someone with extensive experience in this tax area. If your accountant doesn't have this experience, find a specialist who does. A specialist will help catch you up from past years and put a methodology in place for the future. At the same time, you will want to involve your accountant in the process because he or she may be the one to help you roll your R&D methodology forward in the future.
Hear Scott Schmidt speak about R&D tax credit opportunities on March 15, 2007, at 12:30 p.m. at Metal Matters in Lake Buena Vista, Fla. Learn more at fmanet.org-Conference Calendar.