How to Increase the Cash Flow of Your Business
In this period of economic downturn, businesses are seeking ways to generate additional cash flow. Over the past couple of years, the federal government has been providing incentives and bailouts, but there has been little benefit for small businesses. Well, now you are in luck because there is actually a new twist to an old credit that releases the benefit of a powerful tax incentive for small businesses. This mysterious tax benefit is the Research & Development (R&D) Tax Credit. Large corporations have benefited from the R&D credit for years while smaller businesses have been left hanging as their activities may have qualified for the credit, but they were not allowed to use it. Isn’t that ironic, the government creating a tax benefit that you can’t use? Recent legislation has freed up this suspended benefit for 2010. The R&D credit creates “found” money that increases your cash flow.
Which Industries Qualify?
Research and development activities are often perceived as relating solely to high tech or perhaps the pharmaceutical industries. Beyond that, however, many other industries are dynamic and fast-changing thereby requiring companies to continually revise their designs and ranges of products. Examples of industries that qualify include software development, architecture and engineering, food and beverage, oil and gas, chemical and pharmaceutical, manufacturing, electronics, aerospace, automotive, machine building, medical devices, heavy equipment, plastics, tool and die, etc.
What are R&D Activities?
Generally speaking, qualifying activities include establishing new or improved products, processes or software. Examples of qualifying improvements include functionality, performance, reliability, quality and durability. It does not, however, include areas of improvement that relate to style, taste, cosmetic or seasonal design factors. The project or process must be technological in nature and based in the “hard sciences” such as physical science, biological science, chemistry, computer science and engineering. It is important that the activities be part of a process of experimentation. There must be a degree of uncertainty as to how the improvement should be made as well as a degree of uncertainty about the capability or method for developing or improving a product or process. It is also important to note that the R&D credit is available independent of whether the business fails or succeeds in the related research and development activity.
The first step in identifying and quantifying those tax-saving opportunities is to determine whether company expenditures meet the R&D credit definitions. Some examples of activities that may qualify are as follows:
• Designing or developing new or improved manufacturing processes for new products
• Developing new, improved, or more reliable products, processes, or formulas
• Developing prototypes or models (including computer-generated models)
• Designing, developing, or researching automation and/or streamlining of internal processes
• Performing environmental testing
• Improving or designing new manufacturing facilities
• Developing or improving systems and/or software
• Designing, developing, or researching new equipment
• Expending resources on outside consultants and contractors to do any of the above activities
Many companies miss out on R&D credits in qualifying areas such as engineering, quality assurance, purchasing, manufacturing, and information technology installation and implementation due to a general lack of awareness as to the qualifying criteria. If a company has invested resources into any of the above list of activities, including the advancement and improvement of the company’s products or processes, then there likely may be qualifying expenditures.
What are the Benefits?
Qualifying R&D activities generate tax credits. A tax credit is more beneficial than a tax deduction because a credit provides a dollar-for-dollar reduction of taxes owed or taxes paid. Additionally, the R&D expenditures are deductible. This is a unique opportunity where it is okay to double dip. You receive a tax deduction AND a tax credit for the same expenses.
How are the Benefits Realized?
While credits generated prior to 2010 cannot offset alternative minimum tax (AMT), credits generated in 2010 can offset AMT, as well as regular federal income tax. If you cannot use all of the credit generated in 2010, you can carry back the unused credits and get refunds of taxes paid in prior years. Unused credits can also be carried forward.
How Much is the Credit?
Presently, there are two types of R&D credits a company may claim. The first is the regular credit which is generally equal to 20 percent of the “qualified research expenses” that exceed a base amount. If your company does not qualify for the 20 percent credit, there is a second type of R&D credit called the Alternative Simplified Research Credit (“ASC”). The ASC is a 14 percent tax credit on the amount of qualified expenses incurred over the average of the qualifying expenses incurred in the three preceding years. Additionally, state R&D credits are also available.
In conclusion, the R&D tax credit offers great tax-saving opportunities. Many companies are unaware that some of their day-to-day operations qualify for the credit. Because of the unique opportunity available for the 2010 tax returns, businesses who think they might qualify need to take action now.