Why a vital tax credit for small businesses is grossly underutilized — and how Congress can help

The handwriting is on the wall that when the short-term“fiscal cliff” patch is put together, successful small businesses will likely take a hit. Now is the time for business owners to stop fretting, and instead, start talking to their accountants and tax advisors about taking advantage of one most underutilized tax credit available for small business owners – the Research and Development (R&D) tax credit.


The R&D tax credit can be utilized by firms outside traditional science and manufacturing industries. (Paul Sakuma/AP)

However, in working with thousands of CPA firms and businesses across the nation, I’ve found that only one out of 20 small businesses that are eligible for the R&D tax credit are taking this enormous tax benefit – the other 19 are leaving money on the table.

The failure of small businesses to take advantage of the credit is supported by the findings of a 2009 Government Accountability Office study that found that 75 percent of the benefit of the R&D tax credit was going to businesses with receipts of more than $250 million. Businesses with less than $5 million in receipts only received about 7 percent of the benefit of the credit.

Why is this happening? Why are small business owners failing to hold out their cup when the soup is being ladled?

The number one reason is self-censoring. Business owners and their tax advisors have a fundamental misunderstanding of what is required to qualify for the R&D tax credit (not a problem for the Fortune 500 firms that have a thousand tax lawyers on staff). The R&D tax credit is not just about test tubes and lab coats (although those certainly count) – but rather, it’s about an enormous range of activities, like improving an existing product, making a building greener, and reducing the costs to make a product.

The credit can also apply to a wide scope of industries — not just manufacturing, but computer software, architects, engineers, and food processing firms. For the D.C. area in particular, many government contractors and subcontractors should take a hard look at this credit.

Probably the most common words I hear in working with hundreds of small businesses every year across the country, assisting them in taking the R&D tax credit are: “I had no idea this existed” or “I had no idea I could qualify.” The happiest words I hear are small business owners telling me that because of the R&D tax credit, and the $70,000, $180,000, $400,000 they received from the credit, that they have been able to keep their doors open, expand their number of jobs, or purchase new machinery to better compete.

Hugs happen – and that’s rare for tax attorneys.

But while failure to act is the top reason small business owners aren’t taking advantage of this important tax credit, there are certainly steps that Congress and the administration can take now as part of a fiscal cliff deal to make the R&D credit an even bigger bang for small businesses.

That would entail allowing the credit to count against the alternative minimum tax as championed by Sen. Charles E. Grassley (R-Iowa); that is, change the Treasury regulations to ensure that the business-friendly version of the credit – the Alternative Simplified Credit – can be taken on amended returns (as recommended by the U.S. Government Accountability Office) and allow the credit to be used by start-ups as suggested by Sen. Christopher A. Coons (D-Del.).

These steps would improve upon what is already the best tax credit out there for innovative small businesses – that many have never heard of.

Dean Zerbe is the national managing director of alliantgroup, a tax consulting firm based in Houston, Texas, and former senior counsel to the Senate Finance Committee.

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