President Obama’s 2011 budget contains a proposal to make the R&D tax credit permanent. That may be wishful thinking — he proposed the same thing last year, with no luck — but the chances are good that this key tax break will be renewed again for this year. Hugely popular on both sides of the aisle, the credit has been extended every year since its original expiration date in 1986 (with the exception of July 1995 to June 1996).

While we’re sitting around with fingers crossed waiting for Congress to decide, this might be a good time for companies that are unfamiliar with the credit to take a look at what it offers. Misconceptions abound; here are five of the most common.

1. It’s only for the big guys. It’s true that large organizations snag the bulk of the bucks: 65 percent of the $6 billion net credit in 2005, according to the Government Accountability Office (as I noted here). But that’s largely because they’re better informed about the credit and more aggressive in pursuing it. There’s no reason why smaller companies shouldn’t fight for their share of the pie.

“The reality is that even the mom-and-pop job shops — of which there are thousands across the country — mom-and-pop tool and die shops or injection molding companies, a software company with two people … they’re all eligible for the credit,” says Karim Solanji, co-founder and director of tax consulting firm Paradigm Partners in Houston. The paramount question is not whether they qualify for it, but whether they can utilize it. To get the full benefit of the tax break, a company needs to be showing a profit and paying taxes (as opposed to getting by on carried-forward net operating losses.)

There is a drop-off in the benefit among very small companies, where the cost of the documentation may eat up much of the credit, notes David M. Hull, managing partner with Hull & Knarr LLP, a tax consultancy in Greenwood, Indiana. But that’s at the very low end, in the range of a $5,000 to $10,000 potential refund.

2. It’s only for research-focused companies. The credit has an image problem; it’s often perceived as something that’s reserved for companies doing glamorous, cutting-edge research in high tech or pharmaceuticals. In fact, a wide range of firms have R&D activities that could qualify. “Nowhere in the criteria does it say that you have to have degreed engineers, degreed chemists or physicists,” says Chris Henderson, VP of operations with business tax consulting firm SourceCorp Professional Services. “Regardless of whether you’re developing a new component to some other, bigger product or you’re creating the latest drug to cure cancer, the activities, the discovery, the experimentation, the trial and error, the concepts and the processes are the same.”

Improvements to an existing product line can qualify, as long as they go beyond the merely cosmetic, Henderson adds. And so can the process improvements needed to accurately and efficiently manufacture and deliver the products.

3. Every project we do is a one-off, so we don’t qualify. Manufacturers that supply parts or prototypes to other companies often assume that, while their customer may take the tax credit, they themselves can’t because they’re not doing the R&D. But in many cases they’re underestimating the time and effort they put into activities such as experimenting, testing, tweaking processes, and improving the product to meet the customer’s requirements. “The misperception is this: I’m only building and delivering one particular part and getting paid for the time that I spent developing that part, so how can I get a credit for that time?” says Solanji. “And the answer, in fact, is that they may be able to get a credit for portions of their time that they spent on that activity.”

4. Any good accountant can handle it. This is one of the denser parts of the tax code, and some fairly heavy-duty expertise is required. The IRS designated the R&D credit as a Tier 1 audit issue in 2007, and it’s taking a more hard-nosed approach these days, especially to the documentation requirements. It takes some engineering expertise to prepare documentation that can stand up to the IRS’s rigorous methodology; you have to clearly demonstrate how each activity links to specific expenditures. “The tax credit is an engineering question; it’s not an accounting question,” says Hull. “What happens is, companies have accountants look at it, and the accountant has trouble making the case that what happens at ABC company is qualified research.”

Companies shouldn’t let that discourage them from pursuing the credit, though. “Once you determine the qualified research, attaching the numbers is not terribly difficult,” Hull adds. And it’s possible to establish a methodology to make the due diligence routine for future tax years.

5. We’re a government contractor, so it doesn’t apply to us. “We run into a lot of government contractors of various sizes,” says Hull, “and, unless they’re colossal, many times they’re very confused about how much credit they can take. Or they may be scared that somehow they’re double-dipping.” But the purpose of the credit is to reward certain kinds of activity, and Congress, the IRS, and the courts fully recognize that such activities may be undertaken at the request of the federal government.

Finally, don’t forget the state R&D tax credits, which have their own myth — that they don’t add up to much. The reality is that in some cases, a state credit “may be as lucrative, if not more lucrative, than the federal credit,” Henderson points out. “It’s absolutely worth looking at.” Companies tend to focus on their primary location, overlooking sites in other states where R&D may be taking place, and end up leaving much-needed money on the table. ###