You might not think what you do as a creative entrepreneur counts as “research and development.” You’ve heard about R&D Tax Credits before but never thought you could be eligible for them. In fact, more businesses than ever are able to take advantage of these reductions on state and federal tax responsibilities, including those in the creative industries.
Recently, I had a discussion with Yuko Tsuchida, CPA, MBA, and founder of tax consultancy firm Hito LLC. We discussed some of the most common questions business owners have about R&D tax credits, and how creative business owners, in particular, can benefit from them.
Check out the full video below or keep scrolling for answers to R&D Tax Credit FAQs!
What are R&D tax credits?
Tax credits are created by a governmental agency in order to attract, reward, and retain certain types of activities within their jurisdiction. R&D tax credits were enacted back in 1981 to promote innovation in the United States. They were designed to turn our vision of modern America into the reality we see today by rewarding companies undergoing risky research and development with reduced tax responsibilities. Though these were initially temporary incentives, they were permanently extended in 2015 by the PATH Act.
How do I know if my business qualifies for R&D tax credits?
Since their enactment in the ’80s, there have been numerous modifications and expansions of R&D tax credits that allow more businesses than ever to benefit from them. To see if your business is eligible, you can give yourself the Four Point Test by asking yourself the following questions:
1) Is your business technological in nature?
Do you rely on the hard sciences? For some businesses, this could be engineering, physics, or chemistry. In the creative industries, it’s most often computer science.
2) Are you facing uncertainty?
R&D tax code states that you must be “endeavoring to discover information that was uncertain at the outset.” In other words, are you facing a level of risk or the unknown as you develop your product?
3) Are you undergoing a process of experimentation to overcome that uncertainty?
Does your product development involve a series of trial and errors, iterations of design, or evaluations of solutions as you attempt to reach a result? Even if your experimentation has been unsuccessful thus far, you still qualify for R&D tax credits!
4) Are you creating something new or improved?
Are you creating a product or process that is either new or measurably improving upon the functionality, performance, reliability, or quality of the existing product or process? This means changes made for purely aesthetic purposes wouldn’t qualify.
When Hito works with a business, they create an extensive—40 to 80 page—technical writeup to explain exactly how each of these four points is met. Often, owners reach out to Hito because they’re uncertain if they qualify for R&D but don’t want to miss out on an opportunity. Hito can then dig deep into their processes and help highlight overlooked areas that are perfect examples of experimentation and uncertainty for R&D tax relief.
What expenses could qualify for R&D tax credits?
Lots of different expenses qualify for R&D tax credits, like employee wages, 65% of contractors’ fees, supplies, and computer server costs. The only requirement is that they were used solely and exclusively for achieving that new or improved product or process we discussed in the Four Point Test.
Knowing this, you can proactively track, record, and segregate the expenses that go towards research and development in your accounts. For example, you could track the supply and server costs you incurred during production and have those recorded separately from those incurred post-production in order to make the most accurate and beneficial claim.
I’m a startup and not yet paying taxes — can I take advantage of R&D tax credits?
Yes! Around five or six years ago the government changed R&D tax credit laws so that startups could also take advantage of them. Even if you’re not paying federal tax, you can put R&D credits towards payroll tax. Basically, anyone who has a team or is starting to hire can benefit from these tax credits.
I’ve never claimed R&D tax credits before but I definitely qualified in past tax years. Can I retroactively claim them?
For federal purposes, you can retroactively claim R&D tax credits for all open tax years. The statute of limitations for federal taxes is two years, so you can’t go back and claim tax credits from a decade ago. As of the date this is written, however, you could claim them for the years 2018, 2019, and 2020. You can then choose to have it impact that year itself or retain the credit and have it roll over for future use.
Is this a one-time-only opportunity? Or can I claim these credits every year?
You can claim these tax credits every year that you continue to fulfill the Four Point Test! As long as you’re developing or improving your product or process, you’re eligible.
What sort of documentation do I need for R&D tax claims?
It’s always easier to get total and proper documentation if you plan in advance. In a perfect world, Hito would love to have access to designing documents, QA documentation, iteration documentation, exactly what percentage of a contractor or employee’s time went to R&D through a segregated and detailed timesheet, and more when they’re putting together their technical write up.
But this isn’t a perfect world, and sometimes detailed planning like this isn’t possible. In these cases, Hito goes through existing documentation in the business to determine what they can prove with it and which areas need more in case of an IRS audit.
Do I need to be worried about an IRS audit if I make these claims?!
Back in the 1990s and early 2000s, claiming R&D tax credits almost automatically triggered an audit. This hasn’t been the case in decades. The risk of getting audited when filing for R&D tax claims is the exact same as when you’re filing a normal tax return.
The Revel Philosophy when it comes to tax audits is simple: they happen. The overwhelming majority of returns that get reviewed are happening at random, and you can’t fight randomness. For this reason, we advise never shying away from an opportunity that could save you money simply because you’re worried about an audit. If you qualify, and you prepare your documentation properly, you have absolutely nothing to stress about.
What are the benefits of using a specialist firm like Hito to assist with my filing?
Taxes are complicated. There are over 98,000 code sections in federal tax legislation, and even more in each individual state. That’s a lot for one person to keep track of, especially if you’d rather be spending time on the parts of your business you’re truly passionate about.
Taxes are Hito’s specialty. They know how to identify an opportunity, capture it, and provide the needed documentation. On top of that, if there is an audit, they’ll be there to represent you. Hito has gone through this process dozens of times and knows exactly how to navigate claims and audits to be as straightforward and stress–free as possible. That’s why we’ve referred several of our clients at Revel to work with them; we were able to spot that they had an opportunity, and Hito’s specialized knowledge was the right fit.
I’m a creative business owner. What opportunities could I have with R&D tax credits?
As a creative business owner, you know better than anyone the level of innovation your field requires. Your products go through several stages of development and each new iteration brings uncertainty and adversity for you to overcome. It’s this exact business model that R&D tax claims were designed to benefit.
The Four Point Test is a great way to check your initial eligibility. If any of the answers are a hard no — for example, if you rely on a soft science in your business like psychology or sociology — then you can set your eyes on other tax claims or grants more suited to you. If you answered “yes” or even “maybe” to all the questions, then R&D claims are worth looking into.
Specialist firms like Hito can provide excellent guidance and advice as you file for these claims. At Revel, we have over 15 years of experience working with entrepreneurs in the creative industries. Whether you’re still not certain you’re eligible for R&D or are curious about other ways you can find peace and confidence when it comes to tax planning, we have the tech, expertise, and vision to support your unique goals.
Read more about who Revel is and how we can help you here.