Over the past two decades, the food and beverage industry has embarked on significant efforts in food innovation to respond to the demands of consumers. This is evident as you stroll down the aisle in grocery stores or shop online. The product varieties are vast, wellness/dietary options are abundant and packaging designs are unique. The development of these types of items and designs is often eligible for a research and development tax credit for funds that have already been spent.
The R&D tax credit is based upon the activities performed and whether those elements meet what the Internal Revenue Code defines as R&D. This definition includes activities relating to:
- New or improved products or processes;
- New technologies;
- Where a technical uncertainty exists;
- Those requiring a process of experimentation.
Based upon this definition, it’s no surprise that the largest industry that claims the R&D credit is the manufacturing industry.
EisnerAmper has observed that the large food and beverage companies have generally analyzed and claimed the credit where appropriate. However, there is often still an opportunity for small and midsized businesses to evaluate this tax incentive.
Industry activities qualifying for R&D credit
Qualifying activities include:
- First and foremost, new product development activities;
- Manufacturing process improvements where a company is scaling up production and testing batch trials;
- Packaging development;
- Sensory testing;
- E-commerce/payment systems/logistic implementations;Analytics research.
The credit is based upon three eligible costs: wages paid to employees performing the qualified work; supplies used in the testing process; and payments made to outside vendors to perform research on your behalf.
Opportunities for small businesses
For most startups, the R&D credit can be overlooked, because the company is in a loss position and would not have an income tax liability for which the credits could be applied. However, when the R&D tax credit was made permanent as part of the Protecting Americans from Tax Hikes Act of 2015, or “PATH Act,” a new option was made available for “qualified small businesses” to use their R&D tax credits against future payroll tax liabilities. In effect, Congress established a way for qualified small businesses to monetize their credits.
A qualified small business is defined as:
- Having less than $5 million in receipts/sales/income in their tax filing year; and
- Having $0 receipts/sales/income prior to five years from the tax filing for the R&D tax credit.
To illustrate: if a company has less than $5 million in receipts/sales/income in 2019, it would be able to claim the R&D tax credit if it did not earn income prior to 2015. The entity could have receipts from 2015-2018 and still be eligible for the R&D tax credit. For food and beverage startups, this is an excellent way to increase cash flow and save on their payroll taxes.
More than 40 states have adopted R&D tax credits that mirror the definition of qualified activities for federal purposes. In particular, New Jersey updated its credit rules for 2018 and going forward to include additional credit calculation methods. New Jersey and Pennsylvania also have programs where taxpayers can sell their credits if they were not taxable for state purposes. Other states, such as Georgia and New Mexico, allow for refunds against payroll taxes.
The R&D tax credit is often a highly contested item on a taxpayer’s return. This shouldn’t scare companies from claiming the credit where they believe they’re eligible. What it does mean is companies should retain contemporaneous documentation to support the activities qualifying for the credit. This would include test plans, design documents, product requirements, patent applications, etc. Further, it’s recommended that the internal employees track their time to the projects/products worked on. This creates a nexus of time and project/activity that the employee worked on in a given year.
Tim Rankins is a senior manager with EisnerAmper LLP.