As a business leader, you have probably heard of the Research and Experimentation (R&E) tax credit. This dollar-for-dollar reduction of tax could mean thousands of dollars saved for your business. Traditionally, manufacturers, engineers, architects, software developers and other high-tech companies have benefited the most from this general business credit.
Overview of the R&E Tax Credit
- The research tax credit is a wage-based tax credit that rewards companies for investing in qualified research activities. This tax credit dates back to 1981 and over the years more and more businesses have been able to reap its benefits.
- The R&E credit is available for the development or improvement of products, processes, techniques, formulas, inventions and/or software. In addition to qualified wages, companies may capture supply costs for prototype components and tooling (and in some cases the costs for production tooling) as well as 65% of contracted labor spent performing qualified research on behalf of the company.
- Companies can benefit by both deducting the research expenditures and by claiming the credit. The research expenditures are a reduction of taxable income. The research tax credit is a general business credit, and a dollar-for-dollar reduction of tax.
- Generally, the research credit is 20% of the company’s qualified research expenditures in excess of a base amount. Companies must first use the credit to offset tax for the year the credit is generated. However, if additional credit remains, the company may carry the credit back one previous tax year or forward to the next 20 years.
- The current law allows taxpayers to claim Federal R&E tax credits for expenditures paid or incurred prior to December 31, 2011. Your business can amend Federal tax returns to claim R&E tax credits in prior years and establish systems to claim R&E tax credits in the future.
Qualifying research activities
How do you know if your company may qualify for research and experimentation tax credit studies? First, review the checklist below and mark all that apply. Does your company:
- Design new products
- Improve existing products
- Improve manufacturing processes through technology
- Develop new formulas or techniques
- Improve customer part designs to improve manufacturability
- Design tools, fixtures, molds, or dies
- Develop prototypes or models (including computer generated models)
- Apply for patents
- Test new concepts or technology
- Implement robotics or production control software
- Streamline or improve production or manufacturing processes to achieve higher standards in quality and productivity
- Perform certification testing
- Expend resources on outside consultants or contractors to conduct any of the above-stated activities
If you checked any of these activities, your company may qualify for R&E tax credit.
Four basic requirements
To qualify for the R&E tax credit, your research activities must meet four basic requirements:
- Meet the definition of qualified research activities. Qualified research activities are defined as the development or improvement to a business component, which is defined as a product, process, technique, formula, invention, or software.
- The research must be technological. That is, the process of experimentation used to discover the information fundamentally relies upon the physical or biological sciences, engineering, or computer science. Companies may use existing technologies, and may rely upon existing principles to satisfy this requirement.
- Eliminate uncertainty. The research must eliminate uncertainty concerning the development or improvement of a business component. Uncertainty exists if the capability or method for developing the business component is unknown, or if the appropriate design of the business component is unknown.
- Need of experimentation process. Elimination of the technical uncertainty must be accomplished through a process of experimentation, including systematic trial and error, modeling, or simulation.
To complete successfully a research and experimentation credit study, your company should use a project-based or cost center accounting system. While the accounting records will track qualified expenses, your company will also need to maintain records with information on the nature of the research, such as marketing materials, bid packages, patent applications, management reports, engineering drawings.
As high-tech companies continue to generate jobs and add to the tax roles for our county, any advantages can provide a big boost for a company and mean the difference between growing from one year to the next. The research and experimentation tax credit is a reduction of your tax. Will you take advantage of it?