Created with the goal of fostering innovation and technological advancement in the U.S., the Research and Development (R&D) Tax Credit—also known as the Research and Experimentation (R&E) Credit or the credit for increasing research activities—saves businesses billions of dollars each year. However, the majority of those savings are claimed by large corporations, with many smaller and mid-sized businesses mistakenly assuming that their activities would not qualify. In reality, businesses of all sizes in countless different industries may find that their routine activities constitute qualified research, thereby making them eligible for the R&D Tax Credit.
What is the R&D Credit?
Since 1981, the R&D Credit has been incentivizing American businesses to innovate by helping them offset the high costs of research and development. To qualify for the Credit, businesses must incur qualified research expenses (QREs) in the process of conducting R&D activities, such as developing new or improved products, processes, or software. Qualified research activities must satisfy the following four-part test:
- The goal of the activity must be to create new or improve the existing functionality of a business component.
- The taxpayer must intend to eliminate some uncertainty that exists at the outset of the project.
- In attempting to eliminate the uncertainty, the taxpayer must conduct a process of experimentation.
- The process of experimentation must be technological in nature and must fundamentally rely on the principles of the physical or biological sciences, engineering, or computer science.
After years of expiring and having to be renewed almost yearly due to its status as a tax extender, the R&D Credit was finally made a permanent part of the tax code in 2015 under the Protecting Americans from Tax Hikes (PATH) Act. The PATH Act also expanded the Credit’s utility for smaller and newer businesses. Specifically, businesses that have been in operation for fewer than six years, have gross receipts of $5 million or less in the current tax year, and did not have any gross receipts in the previous five years may apply up to $250,000 per year of R&D Credits against their payroll tax liabilities.
Industries that may qualify for the R&D Credit
Since the phrase “research and development” tends to conjure images of test tubes and white lab coats, many businesses have the misconception that the R&D Credit is only available to industries involved in high-tech or scientific research activities. However, businesses in a surprisingly broad array of industries may qualify. The following six industries are just a few examples of those that may be overlooking the R&D Credit:
- Architecture and engineering. From designing energy-efficient buildings to developing plans that use groundbreaking methods in order to accommodate challenging site conditions, architects and engineers often incorporate innovative techniques into their day-to-day work. When these activities involve a process of experimentation that is technological in nature—such as modeling, computational analysis, or performing engineering calculations—and otherwise fulfill the four-part test mentioned above, they may constitute qualified research under the R&D Credit. However, it’s important to note that steps taken solely to improve a building’s aesthetic appeal do not qualify.
- Manufacturing. Manufacturing companies of all sizes may find that activities such as the following satisfy the four-part test and therefore enable them to qualify for the R&D Credit: developing more efficient manufacturing processes; improving equipment or machinery; developing prototypes; evaluating alternative processes in an effort to optimize cost-effectiveness or the quality of products; finding innovative ways to comply with governmental regulations; implementing green technology or sustainable materials; and many others.
- Construction. As with architects and engineers, many construction companies pursue activities with the goal of improving processes or creating higher-quality structures or building components. Examples of qualified research may include pre-construction planning, sustainable and energy-efficient building initiatives, or improving the overall construction process to make it more efficient.
- Brewing. As craft beer has become increasingly popular, the number of breweries across the U.S. has been steadily rising over the past decade. Many smaller brewing companies may not realize that their everyday activities could constitute qualified research under the R&D Credit. For instance, experimenting with recipes or product formulations, testing different packaging designs to extend shelf life, trying new hopping techniques, or conducting quality assurance testing may all satisfy the R&D Credit’s four-part test.
- Aerospace and defense. While the nation’s largest private defense contractors are likely well-acquainted with the R&D Credit, it is often overlooked by the many smaller to mid-sized companies that have contracts with the federal government to develop products for the aerospace and defense industries. For these companies, examples of qualifying activities may include efforts to improve the efficiency of the manufacturing process, developing innovative designs to meet unique customer requirements (including governmental regulations and budgetary constraints), and using robotics or other advanced technology in the design or manufacturing process.
- Lighting and HVAC. With sustainable design becoming the standard for new homes and buildings, energy-efficient lighting and HVAC systems are increasingly important. As lighting and HVAC designers, manufacturers, fabricators, and contractors strive to improve their products to meet higher demands for efficiency, their efforts may enable them to qualify for the R&D Credit. Examples of qualified research activities may include: conducting building information modeling (BIM); testing the performance of mechanical systems; assessing new components and materials; and improving construction methods and processes.
Businesses in these industries and many others may be able to claim the R&D Credit based on QREs—which include wages paid to employees who perform qualified research, amounts paid for supplies, and amounts paid to third parties who are contracted to perform R&D activities—that they incur in the course of conducting qualified research. In addition to the lucrative savings available through the federal credit, many states offer their own R&D Credits. These may be even more generous and typically do not require much additional effort to claim once documentation has been prepared for the federal credit.
At CRG, our team of tax experts has helped businesses in numerous different industries identify qualified research activities and maximize their savings through state and federal R&D Credits. Contact us today to schedule a consultation!