Has your business developed or designed a new product or process? Has it improved upon an existing prototype or software? Has your company in any way done research to develop a different product or method of production? If so, your company might be eligible to claim the federal Research and Development (R&D) Tax Credit.
What Is the Research and Development (R&D) Tax Credit?
The R&D tax credit (also known as the Research and Experimentation Credit) is a tax incentive provided by the federal government for companies that conduct research and development in the U.S. It is meant to encourage and reward companies for taking risks in the name of innovation.
How Can I Qualify for the Research and Development (R&D) Tax Credit?
The R&D Tax Credit is applicable to businesses who incur certain Qualified Research Expenses. These include:
- supplies that are used and consumed in the research and development process
- employee wages for qualified services
- contract research expenses
But not all research is valid under the federal R&D Tax Credit. According to the IRS, Qualified Research is restricted to research that is technological in nature and intended to be useful in developing a new or improved business component. Research that relates to style, taste, cosmetic or seasonal design factors does not qualify. The IRS specifically prohibits the following kinds of research under the R&D Tax Credit:
- research after commercial production
- adaptation of an existing business component to suit a particular client’s needs
- duplication of an existing business component
- surveys and studies (e.g. efficiency surveys, market research and testing such as advertising or promotions, routine data collection, routine quality control inspection or testing)
- computer software that was not developed for internal use
- research conducted outside the U.S. and its territories
- any research in the social sciences (e.g. arts, humanities)
- funded research
But make no mistake, the R&D Tax Credit is not restricted to companies that concoct potions in a lab or code their own software programs. It could very well apply to your company, too. The R&D Tax Credit is applicable across all sorts of industries – agriculture, forestry, mining, utilities, construction, manufacturing, wholesale, retail, transportation, warehousing, real estate, waste management, and more! Don’t let the nature of your business get in the way of what could be a great benefit. All types of companies conduct research and development in some form or fashion – you may come to find out that yours does, too!
How Much Is the Research and Development (R&D) Tax Credit Worth?
Taxpayers are allowed to choose between one of two methods to calculate their tax credit:
- The “traditional” calculation is where the “credit rate equals 20 percent and the base amount is the product of the taxpayer’s ‘fixed base percentage’ and the average of the taxpayer’s gross receipts for the four preceding years. The taxpayer’s fixed base percentage is the ratio of its research expenses to gross receipts for the 1984-1988 period.” (Source: S. Department of the Treasury, Office of Tax Analysis, Oct. 12, 2016). An alternate calculation is used for businesses that did not exist within the 1984-1988 period.
- The “alternative simplified credit” (ASC) is 14% of qualified research expenses (QRE) that exceed a base amount of 50% of the average QRE for the last 3 years. The ASC rate is lowered to 6% if the business had no QRE in any of the last 3 years.
Also, don’t worry if you’re just now finding out about the R&D Tax Credit. The IRS allows you to claim the credit for all open tax years (which is usually three or four years prior to the current filing period), so you can add in qualified R&D expenses from previous years, as well.
How Long Is the Research and Development (R&D) Tax Credit Available?
For the foreseeable future! The R&D tax credit was originally implemented back in 1981, but was not meant to be a long-term tax incentive. However, Congress wound up extending the credit 16 times until finally making it a permanent feature of the tax code. With the Protecting Americans from Tax Hikes (PATH) Act of 2015, Congress officially put the R&D credit on the books without an end date. On top of that, there is no cap on the number of times you can claim the credit. So long as it’s in the tax code and Congress doesn’t repeal it, your business can take advantage of the R&D Tax Credit.
Taxes can be hard for small and medium business owners to navigate. Obscure tax credits and other incentives oftentimes are too difficult to find or seem to only apply to massive corporations. But that is not always the case. The federal R&D Tax Credit may very well apply to your business, and could potentially save you a significant amount of money in the long run. Contact Waltz, Palmer & Dawson, LLC for a consultation to see if you are eligible and what steps you should take next.
For more information on other tax credits and incentives for businesses, see Navigant blog posts.
Should you have questions regarding the federal R&D Tax Credit or other legal needs for your business or would like to schedule a no-charge initial consultation to discuss questions you have about your business, please contact Waltz, Palmer & Dawson, LLC at (847) 253-8800 or contact us online.
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