R&D Tax Credit Opportunities in Times of COVID-19
The COVID-19 pandemic is forcing many businesses to dramatically transform their operating model and to reinvent their offering to customers. In light of these operational changes, companies should revisit their tax strategy to confirm that research and development initiatives triggered by the pandemic are analyzed for R&D tax credit eligibility.
The federal R&D tax credit (officially the Credit for Increasing Research Activities) is a dollar-for-dollar offset of an income tax liability that is generally claimed by businesses developing or improving products, processes or software. The credit often represents 7% to 10% of R&D expenditures such as wages, supplies and payments to third-party contractors. While many large enterprises are familiar with the credit and capture it annually, the COVID-19 crisis could lead more small and medium-sized companies, including service-oriented businesses, to pay closer attention to this lucrative credit.
R&D tax opportunities
The following are four examples of situations triggered by COVID-19 that could lead to research and development expenditures eligible for the R&D tax credit.
Development of e-commerce tools
Restaurants, retailers and service providers are rushing to develop or improve their e-commerce platform in hope of continuing operations without customers in stores. Functionalities need to be developed to support new delivery or pick-up options, applications need to be revamped and the performance of these systems must be improved to withstand increased volumes of transactions.
Financial institutions are developing new features to enhance online banking and medical offices are launching enhanced telemedicine applications for remote consultations. All along the supply chain, businesses are seeking to improve the performance and resiliency of their systems. These projects are likely to include activities and expenditures that qualify for the R&D tax credit.
The move toward working from home and the drastic reduction in travel have also triggered new software R&D projects. The development of scalable and secure remote-working solutions, for instance, could lead to software-oriented R&D projects.
Cybersecurity is a critical concern for most businesses and solutions to protect data with large proportions of the workforce working remotely can be particularly complex to develop and implement. The integration of legacy platforms with modern virtual collaboration tools such as Zoom and Microsoft Team might also lead to complex software development projects that could include creditable activities and expenses.
Manufacturing of PPE and household goods
Many manufacturers across the country are scrambling to transform their standard processes to manufacture personal protective equipment and sanitary equipment or to ramp up the production of high-demand household consumables. The development or improvement of manufacturing processes often require experiments and series of costly trials to reach product specifications. Issues with the supply chain have also led many manufacturers to experiment with alternative raw materials and redesign certain products.
Pharmaceutical and biotech companies, including startups, are racing to develop new drugs and therapeutics to fight COVID-19. Drug development projects are costly and inherently risky. These projects are generally eligible for significant R&D tax credits.
Immediate benefits for startups
Certain startups with less than $5 million in annual revenue can use their R&D Tax Credit to offset payroll taxes. This is a significant opportunity for startups that are not yet taxable from an income standpoint. The utilization of the R&D tax credit against payroll taxes can generate immediate cash flow and should not be overlooked, especially during uncertain economic times when shoring up cash flow is critical to future business success.
Impact on future legislation
Lastly, COVID-19 could have an impact on future R&D tax legislation.
The idea of deglobalizing the supply chain and repatriating the development and manufacture of critical drugs and essential goods is emerging from the pandemic and would require significant investments in innovation and R&D by U.S. companies.
It’s expected that the government will pass additional stimulus and relief legislation in the near future. In Congress, the idea of repealing the Tax Cuts & Jobs Act provision requiring businesses to start capitalizing R&D costs in 2022 and amortizing these costs over a five-year period, as opposed to the current immediate expensing treatment, is gaining traction.
Other ideas raised in recent years to boost research and development in the U.S. include increasing the credit amount, enhancing the R&D payroll credit by allowing more businesses to qualify, and relaxing the restrictions on contract research organizations (CROs) performing R&D on behalf of another taxpayer. This last measure would have broad application in the pharmaceutical and biotechnology industry, given that clinical trials are often conducted in collaboration with CROs.
Lastly, the idea of an enhanced R&D tax credit for organizations developing products that will then be manufactured exclusively in the U.S. could be used to incentivize domestic manufacturing.
Businesses interested in finding out about how they may qualify for the R&D tax credit can reach out to a Kaufman Rossin tax professional to learn more.