The dollar-for-dollar R&D tax credit essentially covers any new or improved process or product a company has introduced, as long as it has a technological element. But you don’t have to invent the next iPhone to qualify. Here’s how the R&D tax credit works.
Many entrepreneurs adapted how they sold their products, their business’s physical premises, how they accepted payments and a host of other aspects of doing business to keep their employees and customers safe and well.
Although many of us associate research & development (R&D) with Silicon Valley tech startups and biomedical companies, some of the work small business owners did to adapt their business was actually R&D.
They may qualify for the research & development tax credit for these efforts under Internal Revenue Code 41. This dollar-for-dollar credit essentially covers any new or improved process or product a company has introduced, as long as it has a technological element. The credit counts against taxes a company owes or has already paid.
How to know if you qualify
You don’t have to have invented the next best thing to the iPhone to qualify. The credit, which took effect in 1981, does not require the product to be brand-new to the world to qualify. Businesses can get the credit for developing a product or process that is new to them.
There are many relatively routine business activities that may qualify. Let’s say you own a brick-and-mortar retail store that suddenly had to build an e-commerce shop to do business during the pandemic and tested the functionality to make it work. It is possible you may qualify for the credit.
Other types of activities that may count are investing in the resources you need to create new or improved products spending money to develop new or better manufacturing or service processes, investing in software and software-related technology (such as artificial intelligence) and any work you did to improve the efficiency of manufacturing and investments you made in patents or patents pending.
The rules of the credit are complicated, so it is important to speak with your accountant to find out if you truly qualify.
Generally speaking, companies can qualify if they made an attempt – whether successful or not – to develop a new or improved process, product, software, technique, invention or formula. The goal of these efforts had to be to increase performance, function, reliability or quality.
They must also have relied on a “hard science” such as engineering, architecture, chemistry, biology or computer science to pull it off and experimented to eliminate uncertainty from how they were operating during the R&D.
See related: How President-elect Joe Biden’s tax plan affects small business
How to know if an R&D tax credit is worth it
As with any tax credit, there is some paperwork you will need to fill out. This can take a significant amount of time. Your accountant can help you assess whether it is worth investing your time, based on the potential rewards of the tax credit.
Bear in mind that tax credits can carry forward one year or back as far as 20 years. So if you’ve been working on a multiyear project to improve some aspect of your business, it could be well worth investigating the R&D tax credit.
With many businesses looking to maximize their cash on hand, it never hurts to look into tax credits for which your business may qualify. You never know – you may free up some cash you need to continue innovating in 2021.