The Trump administration has recently used its authority to impose significant tariffs on a range of countries and certain specific industries. Tariffs are government-imposed taxes on imported goods designed to protect domestic industries, influence trade policies, or generate revenue. U.S. small and midsized businesses account for one-third of U.S. imports, making this issue highly relevant for businesses across the country. Impacts on businesses include higher material costs, supply chain disruptions, cash flow challenges, and pricing uncertainties. With limited resources compared to larger corporations, smaller businesses may struggle to absorb these costs, forcing them to raise prices, reduce margins, or seek alternative suppliers.
The tax code does not provide tools for direct tariff relief, but the right tax strategies can help to mitigate the impact of the tariffs. This Newsletter recently addressed the savings available with the federal credit for increasing research activities (the “R&D tax credit”) under Internal Revenue Code (I.R.C.) Section 41. The R&D tax credit, which incentivizes a wide range of technical business activities, has long been underutilized due to a lack of widespread knowledge regarding the scope and benefits of the program. With pending tax legislation expected to further strengthen the credit, taxpayers should consider how this program may help offset the impact of tariffs.
For businesses that develop or improve products and/or services, the amount of tax savings from the R&D credit depends on the costs incurred for labor and/or materials. Around 10% of the cost incurred is returned as offsets to tax liability. As an example, if the costs of importing materials to build a new prototype increase due to tariffs, then the associated tax credit increases as well. In effect, the credit offsets around 10% of the price increase, which is a meaningful contribution to mitigating the impact.
For labor, there are additional considerations due to the R&D tax credit requirement that eligible labor be performed in the U.S. Small and midsized businesses often do not directly employ labor offshore, but many do contract with service companies (e.g., in software development) that rely partially or entirely on offshore labor. That labor would typically not be subject to tariffs, which are levied on goods, but still represents a trade-off since hiring U.S.-based contractors would make those costs eligible for R&D tax credit offsets. This option may also become more attractive depending on the relative value of the U.S. dollar compared to other currencies.
Businesses faced with unfavorable tariff impacts will likely have to consider a range of actions to mitigate them. Some of those steps may include ways of providing additional value to customers to help reduce the sensitivity of price increases. Or, certain products could be simplified by removing nonessential functionalities. These types of changes often involve significant technical analysis regarding the applicable products and processes. Time spent on such analysis, including the participation of senior leaders, may result in additional R&D tax credits.
In summary, with the federal R&D tax credit there are multiple strategies available to help offset tariffs – and that credit is only one among other savings opportunities. Federal and state tax codes include other credits and incentives that cumulatively apply across a wide range of industries. Yet, every year, companies miss out on billions of dollars in R&D tax credits and other incentives, at both the federal and state levels. Given the current economic uncertainty and the imposition of significant tariffs, it is more important than ever for taxpayers to identify the available opportunities and pursue those that offer meaningful savings. The most common mistake taxpayers make in this area is to underestimate what is available to them and forego detailed analysis. Reach out to us at (202) 455-6010 or schedule a consultation for a tailored review of your savings opportunities.
