Survey Reveals Innovative Businesses Are Missing out on Tax Incentives
Many businesses large and small are missing out on “free money” from government sources – money that could fund their innovation and expansion efforts – according to the 2017 Washington Business Journal Metro DC Poll Innovation Survey, just released in September 2017.
In this same survey, when asked what are their top barriers to innovation, 26 percent of respondents said financial resources (or the lack thereof), making it the second highest barrier in the survey.
If having the financial resources to fund innovation, development and expansion is such a huge issue for businesses throughout the D.C. metro area (including areas of Virginia and Maryland), why do over 40 percent of businesses report they fund innovation initiatives themselves instead of claiming the numerous credits, deductions and grants that are available?
Two possibilities are that they’re either not aware these incentives exist or they don’t know they qualify for them. Take the Federal research and development (“R&D”) tax credit, for example. By some estimates, less than one-third of eligible businesses understand or know they qualify for R&D tax credits – and many of those organizations aren’t claiming the full credit they could be getting.
It’s widely reported that many C-suite business leaders prize innovation. According to this survey, half the respondents reported that they have a formal innovation process, which would indicate that they value innovation and strive to work on new initiatives regularly. Of organizations that don’t already have a chief innovation officer in place, about half plan to create the position in the next year.
So, the question becomes, if so many businesses want to be innovative and even have processes in place for fostering innovation – why aren’t more businesses monetizing the federal and state tax credit programs available to fund their innovation initiatives?
What Was the Goal of the Survey and Who Participated?
The survey, which is a collaborative effort between the Washington Business Journal (“WBJ”), Cherry Bekaert LLP (“the Firm”), McGinn and Company, and Research America Inc., canvasses D.C.-area businesses each year to uncover:
- How important innovation is to them
- What they’re doing to make innovation happen
- What role Federal, state and local government support and initiatives play in funding innovation
Qualified participants have offices located in the metro D.C. area and a job title of director, vice president, president, CEO or another C-suite designation. Their organizations claim annual revenue of $10 million or more. Participants came from WBJ and Cherry Bekaert databases, as well as members of online panels. A total of 150 individuals completed the survey.
What Kinds of Programs Are Out There?
Virginia, Maryland and D.C., in addition to the Federal government, have developed a wide variety of incentive programs to encourage businesses to engage in specific kinds of activities that stimulate the local economy and expand the tax base. There’s a lot of variety among the many programs out there, but some of the common business activities these programs encourage are:
- Create jobs and hire more people
- Invest in real and/or personal property
- Expand and bolster development in economically disadvantaged areas that have been targeted for revitalization
- Develop, invent, innovate and improve (NOTE: The list of what generally qualifies for R&D credits is broad and expansive; check out the R&D tax credit section for details)
Government-sponsored innovation programs usually come in the form of tax credits, grants (usually at the state level) and exemptions and abatements. Many of the programs are aimed at businesses that are already in the area or that want to move to the area.
Given how many survey respondents said they don’t receive any government grants or incentives to fund their innovation, and if the data for how few people claim the R&D credit is any indicator, it’s safe to assume there are many other businesses that qualify for credits and incentives but aren’t claiming them.
If you live in the D.C. metro area (including surrounding Virginia and Maryland), and you’re looking to expand in the next 1-2 years or you’re working on improving or creating products and processes, there could be incentives for which you qualify.
Additional Reading: Quick Reference List of Incentive Program Examples
R&D Credits: Who Is – and Isn’t – Claiming Them?
As mentioned, what WBJ and Cherry Bekaert discovered is that while some companies get funding from grants and tax credits (Federal, state and local), over 40 percent of businesses rely on their own resources to fund innovation rather than on government grants or tax incentives.
Companies with formal innovation processes are more likely to receive government support for innovation. Public companies are more likely than private ones to use Federal, state and local government tax credits.
For the Federal R&D credit in particular, these findings back up data collected by the IRS for the 2013 tax year. The data show that fewer than 10 percent of businesses claim the R&D credit. The exceptions were businesses that fall into one of these categories, broken down by industry (two categories) and gross receipts (three categories):
- Manufacturing (38 percent claim an R&D credit)
- Professional, scientific and technical services (34 percent)
- Businesses with gross business receipts of:
- $10 million to $50 million (20.87 percent)
- Under $25,000 (14.56 percent)
- $250 million or more (13.92 percent)
If you fall into one of these five categories, you’re more likely to claim the R&D credit for the innovative work, products or services you are developing and/or producing.
The largest businesses ($250 million or more in gross receipts) receive the lion’s share of the R&D credit, according to the 2013 data. These large businesses claim just over 85 percent of the total dollar amount of R&D tax credits claimed.
Based on this year’s Metro D.C. Innovation Survey and the IRS’s statistics about the R&D credit for the 2013 tax year, it’s reasonable to assume that many businesses that could claim R&D tax credits aren’t doing so or that they aren’t claiming the full amount for which they might qualify. The question then becomes, why is this happening – and how can businesses claim the credits to which they’re entitled?
What Research Expenses Could Qualify for the Tax Credit?
The Federal R&D tax credit, which was made permanent under the Protecting Americans from Tax Hikes Act of 2015 (“PATH Act”), can be claimed for a surprisingly large number of qualified research activities (“QRAs”). Some R&D activities include (but are not limited to):
- Developing or testing new products and materials
- Developing new or enhanced formulations
- Testing new concepts
- Improving existing products
- Conducting trial and error experimentation
- Designing tools, jigs, molds or dies
- Developing or improving production or manufacturing processes
- Developing, implementing or upgrading systems and/or software
The most basic test of whether or not your QRAs may qualify for a tax credit is to ask yourself, “Am I creating something new? Or, am I making changes that could improve an existing tool, machine, item or process?” If the answer is yes, it’s worth pursuing to determine if your activity could qualify for an R&D tax credit.
QRAs can include (but aren’t limited to) not only material costs but also payroll expenses. Your idea doesn’t even have to be successful – you may still be able to claim a credit for the time and expense you’ve put in.
There are many different variables, such as the gross receipts generated by your company, that can affect how you claim an R&D tax credit. One of the best strategies for claiming every eligible dollar is to work with someone who specializes in R&D tax credits and is well versed in that section of the tax code.
Remember: If you’ve claimed the R&D tax credit on your Federal tax returns, it pays to look into additional state and local credits you could claim, like the ones mentioned earlier.
Tax Credits Can Fund Innovation
Part of what makes these survey findings so surprising is that a majority of respondents indicated that they intend to increase spending on innovation in their 2018 budgets. Being able to claim tax credits and other incentives for activities they plan to do anyway could free up cash flow to fund these activities, making their innovation budgets go farther.
Freeing up cash flow can in turn fund more testing, development and innovation. In some cases, qualified small businesses (typically start-ups) can use the Federal R&D tax credit to offset up to $250,000 of payroll tax liabilities for five years. This credit can be a pivotal tax incentive for a start-up that has generated no or minimal income tax liabilities. Alternatively, the R&D tax credit can also offset Alternative Minimum Tax (“AMT”) liabilities if you are an eligible small business. An “eligible small business” is defined as a business with average gross receipts of $50 million or less for the three preceding taxable years.
No matter how big or small your growth, innovation and R&D activities may seem, whether or not you succeed in accomplishing what you set out to do, it’s always worth asking the question, “Could these activities and expenses qualify for tax incentives or grants?”
One of the best, most efficient and thorough ways to do that is by working with a state and local tax (“SALT”) expert who can provide an objective, third-party assessment of your innovation activities and connect you to Federal tax resources. Innovation activities can mean activities such as job creation, real and personal property investment, and growth and expansion efforts, as well as anything you’re doing to develop, invent, innovate and improve products and processes.
A third-party credit and incentives specialist will not only be objective – they’ll also be intimately familiar with the nuances of what activities and materials may qualify. That could mean a bigger claim for you, if they find activities and expenses you didn’t know qualify. From initial questions to execution of a full R&D study, the right accountant and advisor could help you claim credits worth thousands of dollars to fuel future innovation in your organization.
Getting started can be the hardest and yet also the easiest part of this whole process. To help you get the real numbers on what your QRAs and other innovation activities amount to – and, more importantly, what kind of tax incentives those expenses translate into – reach out to one of us (Warren Martin, CPA, and Stacy LaMontagne, CPA). There’s no harm in just starting the conversation – and you might discover a new way to add to your innovation funding.
About the Authors
Warren Martin, CPA, Partner with Advisory Services at Cherry Bekaert LLP, leads the Technology & Life Sciences practice in the Firm’s D.C. market. He specializes in transaction advisory, risk management and capital sourcing with clients in the technology and life sciences industries. He also has extensive experience in manufacturing, distribution and financial services. Prior to joining Cherry Bekaert, he was COO of a global AMLAW 50 law firm and held multiple partner roles with a Big Four firm. He also co-founded a Virginia-based investment bank that provided sell-side M&A advisory services for technology and government contracting companies.
Stacy LaMontagne, CPA, Partner in Assurance Services, works from the Firm’s D.C. office to provide accounting, financial reporting and audit assurance services for clients within the technology and life sciences, private equity, government contracting and hospitality industries. One of her specialties is assisting technology and life sciences companies with complex revenue recognition treatment related to bundled software and services and other multiple-element arrangements. She also has experience working with international financial reports and currency exchanges, as well as with private equity and venture capital funds. Prior to joining the firm, she was a senior manager and director at one of the nation’s largest accounting firms.