Taking a Fresh Look at the R&D Tax Credit
For most people, thinking about taxes happens once or twice a year. Usually, it’s a mad rush in January to gather the applicable information to share with their accountant, without adequate time taken to revisit any business changes that may have occurred over the previous year. However, it’s important to occasionally take a step back and think about anything you may be missing. When it comes to the R&D tax credit, taking a fresh look – even if you think you don’t qualify – may help find additional tax savings.
What Constitutes R&D for Tax Purposes May Not Be What You Think
When we explain what qualifies as a research and development expense, we often hear, “Wow, that’s a lot broader than I expected.” It’s not limited to white lab coats, test tubes and beakers, artificial intelligence, or the advanced research that is commonly associated with R&D. It can include product development, process or manufacturing engineering, software development, and much more.
It’s not surprising that those who are unfamiliar with the R&D credit find the rules to be different and broader than originally thought. However, we often get a similar response from taxpayers who have claimed the credit in the past. We routinely hear, “I’ve never considered that those types of projects or expenses would qualify as R&D.”
Stepping back and taking a fresh look often helps find additional eligible activities and expenses. Even if you’re familiar with the credit, a recalibration can be helpful. We also find that involving individuals from other areas of the business may be beneficial as they may have a different perspective or additional insights.
After the last two years, it seems like an understatement to say that businesses are constantly evolving. Businesses are currently dealing with a larger remote workforce, rising operational costs, labor shortages, and much more. The positive takeaway is that these types of issues often drive innovation. For example, businesses are developing or improving mobile applications to interact with customers, manufacturers are automating processes due to labor shortages, and companies are finding creative ways to address new challenges.
There are also more subtle changes. Consider these scenarios:
- You had two engineers five years ago when you evaluated the credit. Now the team has grown to six engineers and takes on more challenging projects.
- Three years ago, you didn’t incur a significant amount of prototype expenses, so you never bothered capturing it. Today, maybe those expenses have grown to be significant, or you took on a project where you had to do a large prototype that you wouldn’t normally handle.
- Your accounting system has changed and improved. This leads to opportunities to identify expenses that were not previously tracked or too difficult to find.
If you’ve looked at the credit in the past but haven’t considered it recently, a fresh look may uncover changes to your business that make R&D credits more valuable.
An Evolving Legal and Regulatory Landscape
While the Internal Revenue Code and supporting regulations haven’t changed in recent years, there are new court cases every year that mold and shape how we (and the IRS) view and interpret the rules. Understanding the evolving landscape, including whether there may be more potential benefits or determining whether claiming a certain type of expense is now riskier, is an important consideration.
Better Outcomes and Results
The R&D credit is commonly an afterthought near the end of a large multi-year project. While it’s great that the opportunity was identified, even in the best circumstances it can be challenging to go back and remember all the pertinent details from previous months. We find that discussing the R&D credit proactively throughout the year or immediately following year-end yields the best results.
Talking about the credit criteria sooner allows better identification of applicable activities and projects and allows us to keep supporting documentation neatly stored and available years down the road. Your team’s engineers, developers, scientists, etc. also generally appreciate the ongoing discussions so they don’t have to dig back through old memories and paperwork in order to find the necessary data.
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For more information or to discuss your R&D tax credit options, please contact a KSM advisor or complete this form.
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