You don't have to generate revenues to increase your bottom line. Some of the largest companies in the world, such as Texas Instruments, Mattel, Caterpillar, Google, and others, increase their profits without selling anything. And you can do the same thing.
Big Corporations use the R&D tax credits to cut their tax rate, saving them millions of dollars on their profits. And here's the good news – the R&D tax credit isn't only for the big corporations. It's an incentive for businesses of all sizes to invest in R&D and innovation. The idea is to reward companies for improving current products and technologies and creating new ones, giving them a benefit for taking risks and investing even if they fail.
Small and mid-size businesses, even startups, are eligible to get the tax credit – even for R&D expenses from past years. They are particularly attractive for startups since the R&D is heaviest up front when the company has no income. They don't expire, and you can use them to offset taxes on future profits and include them in certain types of acquisitions.
The R&D tax credits cover many development activities and don't necessarily have to be successful to qualify. Some examples include making improved office equipment (Xerox: $19 million in savings), software (Google: over $300 million in savings), and radios (Raytheon: $31 million in savings). Other activities covered include changes to make the manufacturing process cheaper, greener, cleaner, and quicker, building prototypes, technology research, testing and experiments to prove market viability, researching and filing patents, employing engineers for product development, or outsourcing your R&D activities are all possibilities for the R&D tax credit.
According to an article in Bloomberg, R&D tax credits are a multi-billion dollar program, yet less than 10% of eligible startups and small businesses claim this credit. Startups that did claim it received an average of $151,000 per R&D tax credit claim. For a startup or small business where early revenues are your lifeblood, that can add significant tax savings to your revenues.
You can calculate R&D tax credits in different ways. One of the most common is fifty percent of the average amount your business spent in the previous three years on R&D expenses. So if you spent an average of $100,000 annually for the last three years, you multiply that by 50 percent, and you'd get $50,000. You can use anything you spend above $50,000 the next year as your credit base and multiply it by 14 percent (the tax credit rate) to decide your tax credit. For example, if your company spends more, say $150,000 the following year, you'd have a $100,000 credit base, which gives you a $14,000 tax credit (150,000 – 50,000 X 14%).
But it gets better for startups. Starting in 2017, if your startup is generating less than $5 million in revenue, you can claim a credit of up to $250,000 to offset the employer part of social security payroll taxes.
Here is a list of the four categories of R&D expenses that meet the criteria:
- Permitted Purpose – activities intended to develop or improve the functionality, performance, reliability, or quality of a production process, software, invention, technique, or formula.
- Process of Experimentation – activities to test one or more alternatives such as product prototypes, pilot testing, modeling, or technology simulations to meet a result (e.g., does this product solve the specific problem).
- Technological Uncertainty – activities that rely on engineering, physical, computer, or biological sciences, such as developing new medical devices or drug treatments.
- Uncertainty Test – testing capabilities or methods for developing or improving a product or process to decide if it works.
Every business and industry can qualify for the R&D tax credits, from a fashion designer experimenting with new textiles to a manufacturer exploring ways to cut its ecological footprint—both salaried and contract R&D qualify. Keep records of all your R&D activities, even if it's in your garage, including concepts, designs, pictures on napkins, whatever the case. Also, keep track of your time spent on the actual R&D activities.
Many startups and small companies claim these R&D credits to enhance their exit strategy. Having the credits on their books enhances their value, proving they have technology someone else is likely to want. The tax credits are carried forward for 20 years, meaning the credits are claimed in one year and taken in future years, reducing your tax liabilities when your company starts generating royalties from licensing or revenues from direct sales. The tax credit is also transferable to new ownership with certain acquisitions, which is attractive to potential buyers of your company.
Extracting value from your IP assets doesn't always mean having to wait until it's generating revenues. Effectively managing your IP assets means using them at every life cycle stage. And that requires being smart about taking advantage of the many ways you can leverage your IP. One of those ways is through the R&D tax credit program. It enables your startup or business to turn one of your most significant expenses into an asset, increase your business value and generate future tax-free revenue that goes right to your bottom line.
If you're in an R&D-intensive industry, such as med tech, biotech, pharmaceuticals, or high-tech, then you owe it to your business to view our free workshop – How to Turn Your IP R&D Expenses into Tax-Free Revenue. You'll learn about the R&D Tax Credit – what it is, how to get it, and how to use it as part of your licensing strategy.
The speakers will be me and Greg Pfeuffer, Partner at Mueller Prost CPAs & Business Advisors.
Click here to register for this event: taxcredit.licensingworkshop.com/
Rand Brenner is an IP professional whose passion is helping inventors, startups, and businesses of all sizes use licensing to turn their IP into income-producing products, services, and technologies. His decades of experience run the gamut from medical devices to food technology to consumer products. He's licensed some of the biggest Hollywood entertainment blockbusters including the Batman Movies (1 and 2), and the number one kid's action TV show, the Mighty Morphin Power Rangers. Rand speaks about licensing and is a featured speaker at investment conferences, trade shows, colleges, and startup events. His first book, Hidden Wealth: The Money Making Power of Licensing was released in 2019 and is available on Amazon.com. He's also a published writer with articles appearing in several prestigious trade magazine including The Licensing Journal, Intellectual Property Magazine, and License India. Rand also mentors at the Cal State Fullerton School of Business and Economics and is a judge for their startup business plan competitions.