It saves businesses billions of dollars annually, yet less than ten percent of those savings are seized by small companies. The Research and Experimentation (R&E) Tax Credit, also known as the Research and Development (R&D) Credit, the credit for increasing research activities, or simply the research tax credit, is riddled with misconceptions that cause many eligible businesses to leave substantial tax savings on the table each year.
What is it?
The R&E/R&D Tax Credit was developed in 1981 with the goal of stimulating innovation and technological advancement within the US by helping businesses to offset the high costs of research and development. A victim of yearly political bickering, the credit has never been a permanent part of the tax code and typically expires each year. However, it is almost always renewed retroactively to allow taxpayers to capture savings for the research activities they conducted during the year.
Who is eligible to claim it?
The R&E/R&D Credit is underutilized by many eligible businesses largely because they erroneously assume that their activities will not qualify. Many taxpayers associate the words “research and experimentation” with highly scientific or technological pursuits, or assume that the credit only applies to large corporations. In reality, the credit is available to businesses of all sizes that are engaged in a wide range of specializations, including architecture, engineering, construction, and manufacturing. Additionally, shareholders in S-corporations and similar types of pass-through entities may be eligible to claim the R&E Credit.
What sorts of activities qualify?
Qualified research activities are defined by a four-part test. Essentially, 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 about the project and must proceed to conduct a process of experimentation that is technological in nature and fundamentally relies upon the principles of the physical or biological sciences, engineering, or computer science. Examples of activities that have qualified taxpayers to receive the R&E/R&D Credit include developing architectural designs, pursuing state, federal, or industry certification, green building initiatives for contractors, environmental testing, and developing prototypes or models.
How does it work?
The R&E/R&D Credit is calculated on the basis of qualified research expenses (QREs), which include wages paid to employees who engage in R&E activities and amounts paid for supplies used in such activities. Depending upon which method of calculation the taxpayer uses, the credit amounts to a percentage of QREs over a certain base amount. The credit is somewhat flexible: a business may elect to carry it back one year or forward twenty years according to its income.
What else should taxpayers know about the R&E/R&D Credit?
The credit lapsed at the end of 2014. However, given its long history of being retroactively renewed after lapsing, businesses should continue to consider the credit in their tax planning strategies for 2015. In addition to the federal credit, most states offer some type of tax incentive for research and experimentation. Some of these feature rates that are even more generous than that offered by the federal credit. Finally, businesses seeking to claim the R&E/R&D Credit should be prepared to show thorough documentation of qualifying activities, including plans, diagrams, and timesheets.
If your firm is wondering if your projects qualify for the R&E/R&D Tax Credit, contact Capital Review Group for a Pro Bono analysis. Please call directly 877.666.5539 .
(Sources: http://www.journalofaccountancy.com/issues/2010/mar/20092122, AIArchitect This Week – Architecture Firms Can Get R&D Tax Credits, http://www.ipc.org/3.0_Industry/3.3_Gov_Relations/2008/tax_credit_whitepaper08.pdf, http://www.businessweek.com/small-business/the-rampd-tax-credit-explained-for-small-business-08162011.html, http://bipartisanpolicy.org/blog/what-research-and-experimentation-tax-credit/, http://nydailyrecord.com/blog/2015/04/20/commentary-rd-tax-credits-add-to-benefits-of-green-building).