As part of the Protecting Americans from Tax Hikes Act of 2015, companies that make less than $5 million in revenue per year and have been in business five years or fewer can use the research and development tax credit to offset a portion of payroll taxes.
“This is a big change that gives startups an immediate financial benefit,” Randy Crabtree, a partner at Tri-Merit, told attendees at the Organic and Natural Health Association’s inaugural meeting in Florida Jan. 27.
He explained that previously the tax credit could only apply to taxes, but that most startups’ taxes were lower than the credit because in the first few years they usually are more focused on research and development and are not yet bringing in high taxable revenue.
The result was they could not fully benefit immediately from the incentive or capture potential funds at a time when they likely most need them, Crabtree said.
Another big change to how the credit is applied in 2016 and beyond will be companies that make $50 million or less in revenue per year can now claim the full credit without worrying about dropping below their alternative minimum tax, Crabtree said.
“One of the biggest hurdles to benefiting from the RD tax credit was the AMT,” which is the floor that taxes cannot go below, Crabtree said, explaining that if the differences between the AMT and credit was small enough previously then firms might not see the credit as enough incentive to conduct research in the US.
The other notable change from the Protecting Americans From Tax Hikes Act of 2015 is it made the R&D credit permanent retroactively to Jan. 1, 2015, Crabtree noted. Prior to this the credit had to be reauthorized regularly – making it an unreliable incentive for conducting research in the US and difficult for companies to plan around, he added.
How to qualify
To take advantage of the tax credit, a company’s research and development does not need to be earth-shattering, but it must push the boundary of the company’s knowledge.
This means efforts to formulate a new product, including prototypes and testing, could qualify even if the company next door already makes the exact product or process, but its information is secret, Crabtree said.
The development activities also must be for something new or an improved business component, such as a technique, process or software, and it must relate to a new function, performance, quality or reliability. Likewise, it must be held for sale or business by the taxpayer.
Once that standard is met, the development must be technological in nature and based on a physical science.
The third component to qualify for the tax credit is the development must eliminate technical uncertainty related to capability, methodology or design from the outset, Crabtree said.
The final requirement is that the development must include experimentation, which could include modeling, simulation of systemic trial and error, Crabtree said.
Finally, the credit generally is based on three areas of expenses, including salaries and wages, contract research expenses and supply costs.
All of this can add up quickly, said Crabtree. He noted that one supplement company he worked with reported R&D related salaries of $28 to $45 million per year, wages of $524,000 to $746,000; supplies of $11,000 to $77,000 and outside services of $18,000 to $45,000.
These amounts quickly become worth the documentation required for the credit, especially now that other previous hurdles have been lowered, Crabtree concluded.