As United States-based companies of all sizes look to increase financial returns, it’s important to consider ways to systematically capture both obvious and hidden research and development (R&D) expenditures in order to potentially offset these investments with the R&D tax credit.
The technology industry is well-positioned to benefit, followed by sectors like Automotive and Energy that are rapidly evolving from their traditional business models to leverage technology to provide a competitive advantage.
Understanding the R&D tax credit
For many industries that rely on technology to create a competitive advantage, R&D is one of the most material, high-value benefits for the business. This is especially true in the technology industry, which has one of the highest volumes of expenditures on R&D at approximately 10 percent of revenue. Until recently, tech firms had more incentives to locate their R&D and manufacturing abroad; however, recent strides in U.S. legislation are leveling the international playing field.
Enacted in 1981 and made permanent in December 2015, the Research & Experimentation Tax Credit, also known as the R&D tax credit, is a general business tax credit under Internal Revenue Code Section 41 for companies that incur R&D costs in the US. For those that take advantage of it, the R&D tax credit can significantly reduce their company’s effective tax rate.
In general, the R&D tax credit is taken as an income tax credit and applied dollar-for-dollar to offset a company’s income tax liability. However, as of this year, eligible start-ups or small businesses can apply R&D credits against their payroll tax liability.
The possibility of a new bipartisan proposal that expands the R&D tax credit by up to 25 percentfor companies that perform the majority of their manufacturing operations in the U.S. is generating increased interest, not only because of its potential benefits to the economy (and a company’s bottom line), but also because studies have shown that collocating R&D and manufacturing significantly increases productivity.
Because R&D is a very high percentage of revenue which, when offset by tax credits, can provide substantial savings, it’s critical to maximize these credits and uncover all areas of R&D in the company. Given the permanence of the R&D tax credit, it has become a staple opportunity for companies to exercise annually. With more audit scrutiny, however, creating an efficient and consistent process is crucial for realizing the most benefit.
The benefits of automating the R&D tax credit process
While the R&D tax credit is applicable to businesses of all sizes and all industries for a variety of expenditures, many companies aren’t taking full advantage of the opportunity it presents. That’s typically because the IRS regularly audits research tax credit claims, making meticulous documentation a must. Unfortunately, assembling such detailed documentation is – for most companies – a tedious, costly and time-consuming affair. But with so much credit at stake, more and more organizations are finding a better way.
To make sure your company is making the most of the R&D tax credit, it may be time to consider automation to standardize and simplify your R&D tax credit process. By properly identifying qualified expenditures and maintaining sufficient documentation, automation enables your company to effectively meet IRS standards, maximize your credit, defend that credit upon audit and offset some R&D expenditures.
A standardized and consistent process is especially critical in the tech industry as R&D tax credits are an area frequently scrutinized by the IRS and other state authorities. Automating the process enables you to confidently defend the credit upon audit and provide transparency to the IRS. It’s also a cost-effective alternative to manual calculations and allows clients to contract for third-party tax advisory services only, not software, which can result in significant savings on outside consulting.
From an internal perspective, automation also increases the credibility of the tax department with data providers from across the company as it makes it easier for them to provide high-quality information and improves their user experience.
Automation in action
According to a recent survey of Thomson Reuters customers, 89 percent decided to automate the R&D tax credit process to create a standard and consistent annual procedure. This was followed closely by the desire to obtain more control and visibility over the process, and to achieve more accurate qualified expenditures and avoid errors.
Prior to automation, respondents experienced challenges with gathering data and contemporaneous documentation, as well as overall time, cost and struggles with assembling information from decentralized groups. Post-automation, respondents benefited from better quality of documentation and enhanced coverage of projects, departments and employees performing the research. Automation reduced the R&D tax credit process for respondents by a month, on average. And, after automation, respondents stated that the efficiencies and work product put them in a better position for an audit or review from a tax governing body.
Get the most out of your R&D investment
So, as you consider the strategic direction of your company and construct ways to become more competitive and innovative in the marketplace, make sure you are getting the most out of your R&D investment by getting the tax credits you deserve. Reinvesting that savings can help solidify your company’s continued growth and success now and in the future.
Benefits at a glance
Automating the R&D tax credit process enables companies to:
- Collect data and documentation with ease through electronic surveys (or automated interview notes features) and a dashboard view for tracking and monitoring survey status.
- Determine an optimal tax position to make more strategic decisions through what-if scenarios and year-over-year comparisons.
- Realize integration benefits and organize critical R&D documents to quickly find information in the event of an audit.