Innovation Tax Credit: Don't be a part of the 90% of eligible companies who miss out

Yes, you read that right: 90% of the US businesses that could get money back from the government for innovating don’t claim Innovation tax credits, leaving millions on the table. That’s because many CEOs and business owners either don’t know about it or lack clarity around what expenses qualify and how the process occurs.  

This blog post explains why filing for Innovation tax credits is a good idea and why you should no longer postpone it. 

What are Innovation tax credits? 

The Innovation tax credit (mostly known as the Research and Development tax credit) is a federal—and frequently state—reward that benefits innovative companies. If you invest in innovation to improve your current offerings, whether by enhancing your products, services, or business processes, you can get back tax money. 

Why do so many eligible companies miss out on this opportunity if things are clear? The short answer is a lack of information, mixed with some bureaucracy—it’s really nothing more complex than other tax credit filings. Most company owners don’t know they’re eligible, so they seek money from other sources. 

However, companies of all sizes can claim the R&D tax credit, regardless of whether they have a dedicated Research and Development department. Simply put, if you’re innovating to make your business and operations more efficient, there’s a good chance the government will consider you eligible for this tax credit. 

How your company can benefit

Why is the innovation tax credit so convenient for your business? 

1. Direct reduction of your organization’s tax liability

The innovation tax credit reduces your income tax liability dollar-for-dollar, so if your business owes $100,000 in taxes and you deserve $100,000 in tax credits, your income tax payment to the government can become $0. 

2. No ceiling on the number of expenses and credit claimed yearly

When you file for the Innovation tax credit, you get to list all the expenses that qualify according to the government guidelines. Since you can earn back up to 10% of what you spend on innovation, you can expect to get hundreds of thousands of dollars or even millions. 

3. An extra source of cash flow

If you need the money, you can do more than reduce your tax liability—especially when you claim Innovation tax credits retroactively, and you can expect a higher amount. In this scenario, you can get more than $1 million back to your bank account, depending on your business and how much you spend on innovation. 

4. No requirement with what to do with the funds 

Uncle Sam wants you to have the money back, so no one puts any limits on how you spend it. You can hire more employees, give all staff a raise to assist with retention, buy new equipment, boost sales and marketing budgets to increase revenue, or even spend it on yourself. 

Qualifying for the innovation tax credit 

If you’ve read this far, it’s a sign that you might have earned some money that you can get back with an R&D tax credit. Now that you know how it can help your business, let’s literally answer the million-dollar question: how can you tell whether your business qualifies? 

You can use a four-part test to evaluate your company’s expenses and establish if they’re eligible for innovation tax credits. 

• Part 1:  Are you developing or improving products, processes, techniques to improve function, reliability, performance? 

No, you don’t need to reinvent the wheel or disrupt your industry to qualify. But your innovation expenses must support the creation of new products and services or the enhancement of existing products. It needs to be unique to your business to be considered eligible. 

• Part 2: Did you apply some type of hard science, such as engineering, computer science, biology, or chemistry? 

It’s called innovation tax credit for a reason. Being eligible for research and development tax credits implies a series of activities connected to the four areas listed above and improving upon your existing products, services, or processes or helping you come up with new offerings. 

• Part 3: Was there an actual evaluation of alternative approaches: testing, trial and error, modeling, simulation?

Note that this part doesn’t necessarily imply success. You can still qualify for tax credits even if your project failed, as long as you documented the process and the evaluation. 

• Part 4: Were you trying to learn something new about the product or process being changed to improve it, and could it not be improved without going through experimentation? 

Experiments are necessary for proving or discarding a hypothesis. If you’ve tried to improve your product or service and experimented with reaching this goal, you can qualify the expenses generated by the experiment.

Activities and expenses that qualify 

As a general guideline, activities like design and testing, researching alternatives to an existing product, experimenting with new processes, building prototypes, or exploring green technology to make your product or service better and environmentally friendly can qualify for R&D tax credits. Alternatively, any research that eliminates uncertainty around a product or process or an experiment meant to solve a production problem can also be considered eligible. 

On the other hand, regular inspections and testing, most reverse engineering projects, and studies developed outside the US don’t qualify for the innovation tax credit. Also, if the government is already funding your research project, you can’t use the same expenses to get tax money back. 

When filing for R&D tax credits, make sure you provide thorough information and documentation. For that, you want to: 

1. Identify business areas you can use to claim tax credits according to Section 41.
2. Mark all research activities, name the team members who performed each research activity, and highlight what information each individual sought to discover.
3. Use Form 6765, Credit for Increasing Research Activities to list qualified employee wage, supply, and contract research expenses for the claim year. 

Don’t believe the myths! 

Does the four-part test tell that you qualify, but you still have doubts? It’s normal, as misconceptions around R&D tax credits keep many businesses owners from claiming what’s legally theirs. 

In plain English, you can still claim innovation tax credits even if: 

• Your experiment didn’t go as planned. Uncle Sam will still pay for the journey, even if you haven’t reached the destination this time. It gives you a second chance. Use the money to try again and make your product better. 
• You’re not exactly profitable. The tech giants who claim these tax credits regularly don’t do it because they’re thriving. They’re profitable because they take advantage of every opportunity to boost cash flows. 
• You don’t spend enough on research and development. There’s no ceiling or minimum investment. You will get less money back, but it’s still your right to ask for it. 
• You outsourced R&D activities. As long as your contractors are US-based, you can still claim the tax credit and get your earned money back. 
• You don’t have a dedicated R&D department. The government doesn’t care about job titles and internal organization. If you innovate, it’ll reward you. 

How do you start? 

Claiming R&D tax credits isn’t exactly a breeze. It’s not something you can take care of overnight, and most CPAs don’t have the knowledge or the time to dig through documentation. And that’s the other reason many CEOs and business owners don’t use this tool to boost their cash flows. 

You need a tax credit specialist to work with your team to determine your company’s eligibility and walk through how to claim. With a professional by your side, the process of gathering the documentation needed and complying with the latest IRS guidelines becomes straightforward, and you increase your chances of getting your money back on time. 

Want to better understand how the process works? If you still haven't done it, download our free visual guide How to Claim R&D/Innovation Tax Credits.