Taking Advantage of Research & Development Tax Credits
Section 41 of the U.S. Federal Tax Code provides a benefit in the form of a nonrefundable tax credit for companies that engage in qualified research and development (R&D) activities. These R&D tax credits can create immediate cash flow by reducing current year tax liability dollar for dollar, which can amount to as much as 20% of the excess qualified research expenditures for the tax year over a base amount. While nonrefundable, any credit not used in the current year can be carried back one year and carried forward 20 years. Additional qualifying activities that can be documented in prior years can create additional cash flow in any open tax years, currently three years, by filing an amended tax return.
What Qualifies for R&D Tax Credits?
The following are examples of qualified research expenditure activities for purposes of Section 41, as long as these activities occur in the United States:
- Developing a new or improved product
- Developing new technology
- Creating a new production process
- Improving current processes
- Developing or improving software
- Developing prototypes or models
What are the Expenditures that can be Included in the R&D Calculation?
The R&D tax credit is calculated as a percentage of the company’s expenses related to R&D activities. Qualified R&D expenditures can include operating expenses such as, wages paid to an employee responsible for qualified R&D activity, materials and payments to third party contractors who are performing R&D related activity. One of the benefits of the credit is that while these expenses are fully deductible when determining taxable income, they can also count towards the R&D tax credit.
Should Companies Take Advantage of R&D?
Companies often did not take advantage of R&D tax credits for a few reasons:
- Up until recently, the R&D tax credit was only a temporary provision. Prior to 2015, the credit was usually extended at the last minute or after year end and made retroactively, which resulted in many companies and advisers viewing it as somewhat risky to claim. In 2015, the R&D tax credit was made a permanent provision.
- Complicated calculations, which required companies to have a great deal of historical knowledge about their research activities, accompanied the R&D tax credit.
- Even with a more simplified calculation method released in 2006, companies have not claimed the credit because they are not aware that they even have qualifiable activities.
What Industries Qualify for R&D Tax Credit?
The R&D tax credit can be taken by any business that is currently improving or creating new or improved products, processes or technology. Many of the frequently overlooked industries that can qualify for the R&D tax credit include architecture firms, engineering design firms and software development companies. Even startups that are not generating taxable profits can also take the R&D tax credit against a portion of their employer payroll taxes. This credit is one of the most beneficial tax credits currently offered and is both a federal and state incentive with roughly 70% of states offering it.
Companies should not attempt to claim the credit without professional help. Hiring a tax advisor, who has experience in R&D tax credit calculations, will allow companies to receive help evaluating, preparing and defending their R&D tax credit claim.
If you have questions about the R&D tax credit, contact us today!