DOES THE RESEARCH CREDIT PROVIDE A DOLLAR FOR DOLLAR CASH SAVINGS OF FEDERAL INCOME TAX?

Riz Malik | Source Advisors

5 May, 2020. 7 min read

Companies can create a dollar-for-dollar reduction in their federal and state income tax liability.

Other benefits of the R&D Tax Credit are:

  • Receive up to 12-16 cents of federal and state R&D tax credits for every qualified dollar
  • Increase earnings-per-share
  • Reduce your effective tax rate
  • Improve cash flow
  • Carry forward the credit up to 20 years
  • Perform look back studies to recognize unclaimed credits for open tax years (generally 3 or 4 years)
  • Utilize the federal R&D tax credit against payroll tax (applicable to certain startup companies)

Thousands of companies take advantage of the credit across several industries. Some of the common industries that qualify for the R&D tax credit include, but are not limited to:

The activities that qualify for the R&D tax credit are the same ones driving growth in your business.

  • Creating improved products, processes, formulas, software, and techniques
  • Automating or improving internal manufacturing processes
  • Designing tools, jigs, fixtures, and molds
  • Integrating new equipment
  • Development of data center, big data, and data mining tools
  • Integration of APIs and other technologies
  • Development of financial or pricing models
  • Hiring outside consultants to perform any of the listed activities
  • Manufacturing new or improved products
  • Developing prototypes, first articles, models
  • Evaluation of alternative materials
  • Development of firmware
  • Network hardware and software development and optimization
  • Developing simulators
  • Development of risk management systems

Ensuring that you understand the rules for qualification is an essential first step in claiming the R&D tax credit. This is normally done during a feasibility analysis, also referred to as Phase 1. R&D activities are explored and identified at a high level along with related qualified research expenses (QREs). This information is then used to estimate your federal and state R&D tax credits. Education is key and provides the ability to identify qualified activities and QREs so a more accurate benefit estimate can be determined.

The expenses that qualify for research activities within your company typically include employee compensation, materials, and contracted services. Various forms of documentation are sufficient to support your qualified expenses and may include payroll records, financial records showing supply or contract research expenses, and vendor invoices.

On average, companies are typically able to claim 7-10% of their qualified expenses as a federal R&D tax credit. For example, a single software developer, engineer, or lab technician who receives a W2 of $100,000 a year may generate a tax savings of up to $10,000.

Here’s an example of a case study for a company specializing Mortgage Banking:

With more than 20 years of experience offering a variety of cutting edge loan products, this mortgage banking company has become one of the most respected mortgage bankers in their industry. With branches and loan officers nationwide, they are able to originate, underwrite, close, and fund loans utilizing proprietary financial software.

In order to be able to offer lower rates and fees, this mortgage banking company relies on their software platform. This advanced processing software and automated underwriting system enables them to close loans quickly, at a lower cost. The software is a critical facet in the company’s ability to ensure homeowners have a great experience. This unique software platform required extensive research, development & testing to ensure that it could function within the constantly changing landscape of the mortgage industry from origination and compliance through funding and servicing.

As a result of a referral from their trusted audit partner, the company began a feasibility analysis with Source Advisors. During the process they became confident in Source Advisors’ knowledge and expertise in the R&D Tax Credit area and relied on the education they provided. The feasibility analysis, which was conducted by a seasoned technical director, estimated the potential R&D Tax Credit benefits prior to engagement. Source Advisors’ approach ensured their team understood the R&D Tax Credit up front, which was critical to this company’s comfort in making the decision to move forward with the study.

THE RESULTS SPEAK FOR THEMSELVES

The R&D Tax Credit process is complex, but with Source Advisors’ hands-on consultative approach the company experienced a “seamless process.” In addition, the final credits amounts were 16% higher than originally estimated. Total combined Federal and State tax credits for this mortgage banking company were $520,000 over a 4 year period. The firm continues to realize an annual credit of about $200,000, which they utilize to further grow their business.

Companies of all sizes and across many industries meet the federal government’s test for qualified innovation activities and can claim Research and Development (R&D) Tax Credits. However, many companies are not aware they qualify. There are thousands of companies that are leaving money on the table and not taking advantage of significant federal and state R&D tax credits.

Many people used to think R&D tax credits only applied to those that wear lab coats or create new best-in-class products. This is not the case – R&D credit is much more expansive and far-reaching than most people realize.

In addition, research and development tax credit guidelines for software development have relaxed. All of this opens the door for companies that have not taken advantage of or maximized their R&D tax credits in the past.

These research & development tax credit industries now include manufacturing, software, engineering, financial services, and many others.

If you’re improving or enhancing products and processes to remain relevant and profitable, you may be qualified for R&D tax credits.

These research & development tax credit industries now include manufacturing, software, engineering, financial services, and many others.

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