Written by Chris Blaylock, CPA and Partner - Wipfli LLC
Take Advantage of Opportunities for R&D Credit
First enacted in 1981, the Research & Development (R&D) Tax Credit is one of the most valuable tax credits available to businesses today. While in the past, the R&D credit had expired eight times and was extended 15 times, it was finally made permanent in the PATH Act of 2015. Its permanent status makes planning much more feasible for companies intending to apply for it.
And apply they do. In fact, U.S. companies claim $7.5 billion in R&D credits annually. While many large manufacturing and distribution companies have taken advantage of the credit for years, smaller and midsize companies can also qualify.
The result? Big tax savings: a 20 percent credit for qualified research expenses exceeding a base period based on gross receipts and qualified expenditures, or a 14 percent alternative simplified credit if certain base levels of R&D expenses are exceeded.
The Four-Part Test
With this tax savings in mind, if you haven’t reviewed whether your company is eligible for the tax credit in past years, you may want to reconsider as you move forward. To qualify for the credit, companies must pass the statutory “four-part test” for eligibility:
- New product or process: You create a new product or process, formula, invention, patent or software — or improve an existing one, intending to improve function, performance, reliability, or quality
- Technological in nature: You participate in technological activities based on sound scientific, physical science, biological science, computer science or engineering principles.
- Elimination of uncertainty: You try to eliminate technical uncertainty about the development or improvement of a product or process related to the capability, method, or appropriate design.
- Process of experimentation: You evaluate alternatives for achieving the desired outcome using modeling, simulation, testing or trial and error.
For manufacturers and distributors, some qualifying activities meeting these criteria might include developing custom equipment or processes to produce a product to exact customer specifications. Developing a prototype or model of a new product or process, or designing tools, jigs, molds and dies might also qualify. In addition, attempting to use
new materials, or designing, developing or modifying equipment might meet the test.
Over the past 30 years, however, there have been a number of changes in which activities qualify. Contrary to popular belief, the research tax credit isn’t limited to high-tech, biotech, and pharmaceutical companies. If your company does any of the following, you may qualify for the research credit:
- Design and/or manufacture products
- Produce parts to customer part prints or specifications
- Custom design and build machines for sale or use in operations
- Develop new, improved, or more reliable products/processes/formulas
- Design tools, fixtures, jigs, molds, or dies
- Develop or apply for patents
- Develop software
Small Businesses & Start-Ups, Too
The PATH Act of 2015 also opened the door to even more companies qualifying for the R&D credit. For example, for tax years beginning after December 31, 2015, businesses with an average of $50 million or less of gross receipts for the prior three years can claim the credit against their Alternative Minimum Tax liability.
Start up companies also have an R&D tax credit opportunity. If a company did not have gross receipts for any tax year before the five-tax year period ending with the calculation year, and has annual gross receipts less than $5 million in the current year, the R&D credit can be used to offset up to $250,000 in payroll taxes.
Be sure your recordkeeping is up to date because you must be able to provide documentation that substantiate that expenditures are eligible for the credit on a project by project basis.
Finally, note that if a company is unable to utilize the credit in the current year, the R&D credit carries back one year and forward for 20 years to offset tax liability from the entity. Companies also have the availability to go back and amend prior year returns to claim the credit.
About the Author
Chris Blaylock is a partner and the leader of Wipfli LLP’s research tax credit team in Illinois. He has over 13 years of experience and helps clients claim and substantiate tax incentives for research and development activities.