Research and Experimentation Tax Incentives

What is the Research and Experimentation (R&D) Tax Credit?

Formally known as the Research and Experimentation Tax Credit, the R&D credit is a tax incentive given to companies who are in the business of developing products that are lighter, faster, more durable, less expensive, more reliable, or more precise.

The Research Tax Credit isn’t just for high-tech manufacturers or medical researchers. In fact, more companies than you would think to qualify for the credit, including those in the business of product development, including manufacturing processes, software development, environmental improvements, and quality enhancements of almost any type of product.

Also, companies that invest significant resources to design and build parts, equipment, or infrastructure according to customer specifications. In many cases, if a risk of loss exists relating to the designs, these costs may qualify for the credit as well.

Qualifying Companies Include:

  • Aerospace and defense
  • Semiconductor
  • Software
  • Manufacturing
  • Life Sciences, Including pharmaceutical and medical sciences
  • Construction and engineering
  • Foodservice and processing
  • Chemicals and plastic
  • Many others (retail, financial, oil and gas, telecom, automotive, etc.)


Qualifying Expenses Include:

  • Payroll (includes Box 2, W-2 wages for all employees involved in the research, including supervisory and support staff)
  • Supplies consumed in the process
  • Certain subcontractor expenses

01

To qualify for a research tax credit, a company must be able to demonstrate that a process was used to evaluate alternatives in order to achieve the desired result. This could be through modeling, simulation, systematic trial, and error, or other methods.

A pharmaceutical company could use a series of trials to find the best chemical formula for a new drug, or a software developer might run A/B tests to assess user experience.

PROCESS OF EXPERIMENTATION

02

The process of experimentation described above must rely on hard sciences and data. This part of the test is formally referred to by the IRS as the “Discovering Technological Information Test.”

“In order to satisfy the technological in nature requirement for qualified research, the process of experimentation used to discover information must fundamentally rely on principles of the physical or biological sciences, engineering, or computer science. A taxpayer may employ existing technologies and may rely on existing principles of the physical or biological sciences, engineering, or computer science to satisfy this requirement.”

What does this mean? You don’t qualify for a R&D creditjust because you sent out a Survey Monkey poll about your product.

TECHNOLOGICAL IN NATURE

03

The qualified purpose requirement, also known as the Business Component Test, requires businesses to show that they conducted the research in order to create a new or improved product or process. For companies seeking to improve an existing product, the goal of the research should be to increase performance, function, reliability, or quality.

The IRS defines a business component as any product, process, computer software, technique, formula, or invention, which is to be held for sale, lease, license, or used in a trade or business of the taxpayer.

Many companies attempt to qualify for the R&D credit for their general research and experimentation work, but the IRS requires taxpayers to tie the research to a specific business component.

QUALIFIED PURPOSE

04

Was the research conducted to determine if the new product or process would be feasible for future development, and how? If the answer is yes, it likely satisfies this portion of the four-part test.

The IRS says federal research and development tax credits and costs qualify “if they are for activities intended to discover information that would eliminate uncertainty concerning the development or improvement of a product. Uncertainty exists if the information available to the taxpayer does not establish the capability or method for developing or improving the product or the appropriate design of the product.”

In other words, a company can’t claim a Research Tax Credit for their work developing a product they know without a doubt will be successful.

UNCERTAINTY


Frequently Asked Questions about Research Tax Credits

While many tax preparers understand the basics behind the Research and Experimentation Tax Credits, it takes a professional who works in this field on a daily basis to truly understand all the rules and complexities that govern the R&D Credit, both at the Federal and state levels. We will actively partner with your CPA to ensure proper use and maximization of your R&D Credits.

Perhaps. If you are seeking the R&D Credit for the first time as a company, and you have been performing R&D activities for several years, it may benefit you to calculate your credits for prior tax years to take full advantage of the study.

The cost of an R&D study is based on time and expenses. The more complex the situation, the more time and expense that will be incurred. In general, the benefits of the study end up being three to six times the cost. Fees paid for an R&D study are also tax deductible.

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