Practice Management | March 2022 Hearing Review

Certain activities qualify for tax credits that may result in an important financial boost for your practice

By Chris Lake and John Malan, AuD

Created in 1981 to stimulate research and development (R&D) in the United States, the R&D tax credit is a dollar-for-dollar offset of federal income tax liability and, in certain circumstances, payroll tax liability.  Although widely used by larger businesses, the tax credit was specifically modified to also apply for small and mid-sized companies.

There is a substantial tax benefit for the companies of audiologists and hearing aid specialists that may be overlooked by even the best accountants. Unfortunately, and somewhat surprisingly, not all CPAs know about or take advantage of this money-saving opportunity, which has been on the books for almost 40 years.

In 1981, the R&D Tax Credit (also known as the Research and Experimentation (R&E) tax credit), was enacted as part of the Economic Recovery Tax Act1 to provide an incentive to American companies to invest in research and development (R&D). The goal was to encourage innovation, revitalize American business, and drive US economic growth. That is still its purpose today and, while large US businesses have been taking advantage of this tax credit for decades, it remains largely unknown to the small- and medium-sized business community. 

In 2004, the program changed markedly.  Instead of needing to invent something new, Congress changed the requirement to something “new to you.” With the constant change we experience in hearing healthcare, private- practice audiologists not only need to keep up with those changes, but many actively contribute to the ongoing development by manufacturers.  

This, along with the 2014 Suder vs IRS tax court decision2 that allowed small business owners to claim the credit by estimating the amount of R&D in their business as a percentage, made the credit very accessible to private- practice hearing care professionals.

What Qualifies?

What qualifies for R&D tax credit is based on the activities in which a particular business is engaged. These activities are broadly defined in law and must pass the following four-part test: 

  1. Permitted purpose: To qualify for the R&D credit, the activity must relate to a new or improved business component’s function, performance, reliability, quality, or composition. 
  2. Technological in nature: The activity performed must fundamentally rely on principles of physical sciences, biological sciences, computer science, or engineering. 
  3. Elimination of uncertainty: The activity must be intended to discover information to eliminate uncertainty concerning the capability or method for developing or improving a product or process, or the appropriateness of the product design.
  4. Process of experimentation: The qualifying activities must constitute the process of experimentation involving simulation; evaluation of alternatives; confirmation of hypotheses through trial and error; testing and/or modeling; or refining or discarding of hypotheses.

Activities you engage in that meet the four-part test criteria qualify. 

Why Haven’t I Heard About Them?

We live in a complex tax world. With over 74,000 pages in the current tax code, it is virtually impossible for CPAs to keep up with it all. In addition, the R&D credit is a specialty: it requires specialized software and documentation of activities that most CPAs don’t include in their practice. It would be like going to a family practice physician to handle your hearing—they should refer you to a specialist.  However, if you Google R&D tax credits, you will get thousands of hits. In April 2019, Forbes stated that this is one of the best tax credit opportunities for small- to medium-size businesses.3 

How Does It Work? 

If you are interested in checking this out, there are many companies who will conduct a free analysis of the potential R&D credits.  

Different companies use different processes to submit for the R&D credits. Some require detailed time sheets and write-ups in order to claim these credits. Others create expensive and time-consuming 200-page reports to back up the claim.

One of the simplest methods, however, and an excellent option for small- to medium-sized hearing care practices, involves an interview with the business owner, followed by an analysis of activities and tax documents to determine eligibility. This is a far less intrusive process for the business and offers a way to apply for this credit easily without a major distraction to business operations. 

On a Personal Note…

When the second author (JM) first heard of R&D credits being applied broadly, I was skeptical because I was sure I would have heard of it by now—and I certainly never want to be on the bad side of the IRS. After conducting the necessary due diligence with my extremely strict CPA, I decided (as a proof of concept) to see if my own business would qualify. I applied for R&D credits, and frankly did not expect much to come of it.  To my surprise, I qualified and received $54,000; I quickly became a believer and have since helped many audiology practices in a number of states apply for and receive R&D tax credits. However, it should be obvious that you need to perform your own due diligence and use a reputable professional service when applying for this tax credit.

Conclusion

In our view, the majority of small- and medium-sized practices are not taking advantage of the R&D tax credits created specifically to help them innovate and improve their businesses.  As a result, these companies are giving up money that is rightly theirs—money that could drive growth and improve efficiencies, help with existing expenses, allow additional hiring, and help address the many financial issues keeping business owners up at night and/or from expanding into important areas where consumers need us to be.

Editor’s Note: As with any financial and tax advice, be sure to check with a tax accountant and/or attorney to verify that the financial topics discussed here pertain to your own specific business situation.

Correspondence can be addressed to: Ms Lake at [email protected] or Dr Malan at [email protected]

Citation for this article: Lake C, Malan J. R&D tax credits: A potential tax tool for hearing care practices branching into new areas. Hearing Review. 2022;29(3):26-27.

References

  1. 97th US Congress website. HR 4242 – Economic Recovery Tax Act of 1981. https://www.congress.gov/bill/97th-congress/house-bill/4242.
  2. Leagle website. Suder v Commissioner of Internal Revenue. https://www.leagle.com/decision/intco20141001e65.
  3. Zerbe D. R&D Tax Credit — Still the One for Small and Medium Business Owners. https://www.forbes.com/sites/deanzerbe/2019/04/26/rd-tax-credit-still-the-one-for-small-and-medium-business-owners/?sh=41825ae52910. Published April 26, 2019.
  4. US Internal Revenue Service (IRS) website. IRS sets forth required information for a valid research credit claim for refund. https://www.irs.gov/newsroom/irs-sets-forth-required-information-for-a-valid-research-credit-claim-for-refund. Published January 5, 2022.
  5. Office of Chief Counsel Internal Revenue Service. Memorandum: I.R.C. § 41 Research Credit Refund Claims. https://www.irs.gov/pub/irs-lafa/20214101f.pdf. Published September 17, 2021.
  6. US Internal Revenue Service (IRS). Form 6765: Credit for Increasing Research Activities. https://www.irs.gov/pub/irs-pdf/f6765.pdf. Published December 2020.