Do you qualify for r&d credit? How to tell
Bryan Ross,
Eide Bailly LLP:
952.918.3502
bross@eidebailly.com
www.eidebailly.com
ABC Manufacturing Co. has spent the last two years improving their internal processes related to customer fulfillment. Although the project was arduous at times, the end result is a streamlined process that allows the company to fulfill customer orders in 10 percent less time, with 25 percent greater accuracy and at 20 percent less cost.
ABC Manufacturing Co.’s owners are ecstatic about the results they have achieved and the resulting increase in their customers’ satisfaction. However, the owners may be leaving money on the tablemoney they are not even aware they are eligible to receive.
Since 1981, the Internal Revenue Service has encouraged companies to develop new products and processes by offering a research and development (R&D) tax credit. The list of activities that qualify for this credit has grown substantially since the credit’s introduction, but many business owners are unaware the credit exists, let alone the benefits it may bring to the business.
Business owners who are aware of the credit are often under the mistaken impression that they must be involved in significant R&D or technological activities to qualify for benefits. In fact, many companies meet the criteria for the R&D credit simply through their ongoing efforts to remain competitive.
What expenses qualify for r&d credit?
Many of a company’s day-to-day business activities qualify for the R&D tax credit, including the following:
- Development of new, improved or more reliable products, processes, formulas or techniques.
- Development of prototypes or models (including computer-generated models).
- Design of tools, jigs, molds and dies.
- Development or testing of new concepts or technologies.
- Development or improvement in production or manufacturing processes.
- Development, implementation or upgrading of software.
- Automation and/or streamlining of internal processes.
Companies whose business activities meet these criteria are already experiencing improved operations and results due to their efforts. Taking advantage of the R&D tax credit provides even greater benefit through tax savings.
These tax savings are not limited to the current year; in many cases, tax credits can be retroactively applied to prior years when the R&D activities took place and may carry forward to future years.
What industries qualify for r&d credit?
More than manufacturing
Another misconception about the R&D tax credit is that the credit primarily benefits manufacturing companies. Although manufacturing companies have significant opportunity to take advantage of the R&D tax credit, other industries may also benefit from the credit. These industries include the following:
- architectural services
- construction materials
- engineering services
- environmental services
- information technology services
- metal stamping
- printer supplies
- software development
In general, in order to qualify for the R&D tax credit, software development must primarily be for purposes other than improving a company’s general and administrative services. The following types of software development will generally qualify for the credit:
- Development for commercial sale, lease or license to an unrelated party.
- Development of software and hardware developed together as a single product.
- Development for use in the qualifying development or improvement of a production process business component.
- Development used to provide computer services to the company’s customers.
- Development for specific use in activities that qualify for the R&D tax credit.
For federal income tax purposes the research tax credit expired on December 31, 2009. However, an extension of the credit has been proposed in several House and Senate bills. While not ensured, it is anticipated that an extension of the credit will be made before the end of 2010.
In late March, the Minnesota House and Senate passed a package of tax cuts referred to as the “jobs bill.” This legislation, designed to stimulate job growth in the state, was signed by Gov. Pawlenty on April 1. One of the bill’s provisions makes three positive changes in the R&D tax credit for Minnesota businesses.
First, the credit increases from 5 percent to 10 percent of the first $2 million in research and development expenditures over the base amount. Additionally, the credit has been expanded from being applicable only to C corporations to being applicable to S corporations and partnerships, as well. Finally, the R&D tax credit is now refundable and not tied to a business’s tax liability.
Unfortunately, neither the IRS nor the “jobs bill” has simplified the process to qualify for the credit. The IRS requires extensive documentation of the qualified research expenditures and often scrutinizes the company’s qualification for the credit more than the actual amount of the credit.
The documentation required to support the claim has significantly increased over the past few years. If your company is interested in exploring whether these credits may apply to your business, be prepared to spend time collecting and analyzing data that support why the company qualifies for the credit.
New info
In general, activities that qualify for the R&D tax credit should have the objective of discovering some technological information that is not already in existence for the company or the industry. Additionally, there must be a level of uncertainty related to the development process. This uncertainty encompasses the capability, method, design or appearance of achieving the desired result.
If 80 percent or more of the time related to the project involves efforts to eliminate these uncertainties, it is likely the project will qualify for the R&D tax credit.
The IRS uses two other criteria to determine whether activities qualify for the R&D tax credit. The first is whether the costs of the activities are directly attributable to a “process of experimentation” with no guarantees of success. Secondly, the activities should have a general business purpose, which could include the pursuit of federal, state or industry certifications.
In this time of limited resources, is it worth the time and effort to determine whether your company’s activities qualify for an R&D tax credit? Spending time upfront analyzing some of the initial qualification guidelines will provide companies with enough information to know whether they should continue to invest time in exploring the credit.
If the initial analysis shows that there is potential for the credit, companies should work with their tax adviser to determine how the credit will benefit them.
