Many small businesses are missing out on this potential tax credit

Many small businesses are missing out on this potential tax credit (Courtesy of the Jacksonville Business Journal) — Beauty product startup Alleyoop Inc. started in 2019 and has grown rapidly ever since.

The company is poised to hit eight figures in revenue in 2023, and has grown to about 20 employees, according to Chief Operating Officer David Manshoory, who joined the company following its founding by his wife Leila Kashani Manshoory. The company’s makeup, skin care and body products are aimed at reducing the time it takes to get ready, and the company has poured money into researching and developing its own products.

So when David Manshoory found out he could recoup some of that spending back in the form of the federal research and development tax credit, he was skeptical.

“I was very skeptical even when I did it because the government puts a program out there like this, I didn’t know how much we would have to go through to earn the benefit,” he said.

The company has since recouped about $223,000 from the tax credit, money that can be put back into the business and money that can help them retain more ownership of the company without having to go back to investors for more.

“I would say it was very little time investment on our part with what it ended up being. So now I am like a huge fan,” Manshoory said.

Experts say one consequence of the pandemic has been a heightened interest among business owners in tax credits and government lending programs like those administered by the Small Business Administration.

Now that the bulk of Covid-19 relief funding has dried up, there could be more interest in programs like the R&D tax credit.

Who qualifies for the R&D tax credit?

Joshua Lee, founder and CEO of Ardius, a startup owned by payroll and benefits provider Gusto Inc. that helped Alleyoop navigate the process, said businesses can qualify for the research and development tax credit if their spending meets some criteria:

• The research needs to be for a permitted purpose and end goal. It cannot be research for the sake of research, such as a university.
• Some level of uncertainty. There needs to be some process of experimentation that could involve failure. Is the research testing and evaluating alternatives? Is the company trying different things?  Ultimately, the company doesn’t have to be successful to qualify for the credit.
• It has to be technological in nature. Something that involves math, technology or “something you might find in a fifth-grade textbook,” Lee said Improving a manufacturing process would count too.

The complexity of the credit means that most of the benefits have traditionally went to the largest companies.

“It’s the SMBs and the small businesses that have missed it. It’s not on their radar because they are trying to build their business — not claim tax credits,” Lee said.

Businesses were previously able to deduct research and development in full from that year’s taxes, but that has ended. The Tax Cuts and Jobs Act passed in 2017 changed the tax code from expensing R&D spending in the year it happens to having businesses amortize those costs over five years starting in 2022 — which experts say will hurt research efforts and put the United States at a competitive disadvantage. 

But the ability to deduct R&D expenses from taxes is separate from the R&D tax credit, which rewards certain kinds of research and is spread across several components. More on the tax credit can be found here.

Other tax credits and SBA funding options for small businesses

And small businesses that missed out on the SBA’s Economic Injury Disaster Loan or industry-specific programs like the Restaurant Revitalization Fund still have a potentially lucrative Covid-19 relief opportunity available in the form of the Employee Retention Credit.

Attorneys, accountants and professional advisers say small businesses would be wise to give the ERC a second look if they haven’t already applied. Relatively few business owners have taken advantage of the Employee Retention Credit, according to a survey of more than 500 business owners by technology firm Clarus, which helps businesses claim the credit and concluded that only one-third of restaurant owners had taken advantage of the ERC. Experts told The Playbook that small-business owners should document everything, in order to make sure they can prove their case if the IRS has questions.

Here are some other grants small business owners can apply for right now.