Double Your Cash Flow with the Innovation Tax Credit

Creating innovative products and services for your growing business may be second nature to you, but what’s not often second nature is claiming the innovation tax credits the government owes you for those efforts. 

When your business is innovating, there’s a clear path to double your cash flow the following year—all thanks to those handy tax credits. Having a strong cash flow can open up a ton of great opportunities for your business and have an enormous impact on your yearly growth.

So, what is the innovation tax credit?

If you’re wondering what this tax credit is, you are not alone. 90% of eligible U.S. businesses don’t claim the innovation tax credit because they either don’t know about it or don’t realize they qualify for it. 

This tax credit is a federal (and frequently a state) reward that the government gives to benefit companies that are innovative in a variety of different ways. Essentially, the innovation tax credit reduces your income tax liability dollar-for-dollar, so if your business owes $300,000 in taxes and you have $300,000 in tax credits, your income tax payment to the government is $0. 

The innovation tax credit has been around at the federal level since 1981, but many businesses have misconceptions about its application since it is usually called the R&D tax credit (or the research and development tax credit). When business owners hear “R&D tax credit,” they often think they won’t qualify because they don’t “do” R&D. Truth is, if you are innovating in nearly any way, the government probably considers you eligible for the R&D (or innovation) tax credit. 

Here’s the main qualifying question: Does your company develop new or improve upon existing products, processes, techniques, services, or software? If you answered yes, there’s a good chance your business qualifies for the R&D innovation tax credit. The innovation credit rewards companies who are making their product or service cheaper, faster, more efficient, or greener. If you haven’t been selling the exact same product or service for the past 5-10 years, your company is an excellent candidate for the R&D tax credit.

What qualifies as “innovation”?

The innovation tax credit has a range of expenses that qualify for it. Each person, project, and equipment or supply purchase that is involved in your yearly innovation initiatives could qualify. To qualify these expenses to the IRS, your company can use time records, interviews with team members, financial statements and other sources of data to reclassify your expenses as qualified research expenses. This takes some finesse, which is why a lot of CPAs prefer to let R&D specialists handle cases for the innovation tax credit. Fortunately, working with an R&D specialist has its advantages, such as the IRS preferring third-party reporting on R&D claims.

How can the innovation tax credit work for my business?

If your business is potentially eligible for the innovation tax credit, you may be wondering how it will benefit you, specifically. Let’s look at the numbers: For every $1 in qualified expenses, you get $0.10 in innovation tax credits. This adds up quickly! If your company does a $1,000,000 infrastructure overhaul, you can get $100,000 back in innovation credits, or even get $1,000,000 back on a $10,000,000 investment. The government believes innovation should be rewarded, and your company can benefit from the innovation tax credit.

Also, the money you are awarded in innovation tax credits rolls over for up to twenty years! If your company has a down year (like the 2020 pandemic year, for instance) and has a lower tax liability, any excess credit can be carried forward to use against future tax payments. So, if you are awarded more money in innovation tax credits than your business needs to pay in taxes, not only will you pay no taxes this year but what’s leftover will also take a chunk out of next year’s tax payment. 

How do tax credits improve my cash flow?

There are two main ways the innovation tax credit can improve your cash flow: by retroactively claiming the credit to get a refund and by claiming the credit every year moving forward to reduce taxes. 

Your business is allowed to go back three years and claim credits for the innovative work you did during those periods. Once your claim has been calculated and supported with appropriate documentation, your company can request that the IRS return the amount of the credits to you in cash. This one-time benefit allows companies who are new to innovation tax credits to obtain a massive cash inflow. In many cases, the money a company receives for the prior three years of tax credits is more than that year’s cash flow.

Moving forward, claiming your innovation tax credit yearly means a dollar-for-dollar reduction on your taxes. For every dollar in tax credits you earn, you pay one less dollar in income taxes. Not needing to cut a big check to Uncle Sam at the end of the year means your business has more cash flow to work with for the rest of the year.

Let’s look at a real life example of a company getting an influx of cash to show the impact of the innovation tax credit. One company we worked with was a niche software and services company with roughly $8-12 million in revenue. Our tax credit study uncovered and substantiated roughly $5,000,000 in qualified expenses for every year from 2016-2020 and received approximately $500,000 in innovation tax credits for each of the four years we studied. In total, this company was able to recover almost $1.4 million in cash from the IRS while reducing their 2020 tax liability by nearly $500,000. Receiving an additional cash infusion of approximately $1.9 million dollars to their business was a game changer for them.

It’s easy to see that the innovation tax credit can be a game changer for your business. Going back and claiming the money you’re owed can even double your cash flow in a year! So, the real question is, why not take advantage of this tax credit and get your money back?

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