ASK ANY business owner if they would be interested in reducing or eliminating their federal and state tax liabilities, and I think we can all agree that the answer would be a unanimous yes. If you asked those same business owners if they had ever heard (or taken advantage) of the federal research and development tax credit, the majority would say no.
For those of us in the accounting and tax services industry, this is an area of interest. As trusted advisers, it pains us to see qualifying businesses miss out on available tax savings each year.
When most people hear the term “research and development,” they immediately think of science, technology and pharmaceuticals, often overlooking some of the most viable industries. This way of thinking has introduced a recurring issue when discussing R&D tax credits with potential clients. Too often their response is, “We don’t qualify. We don’t do any research.” This is an unfortunate way of thinking and often results in the loss of a lucrative tax incentive. It’s estimated that only about 15 percent of qualifying companies take advantage of this credit each year.
What is the R&D tax credit?
Officially known as the Credit for Increasing Activities, commonly referred to as the R&D tax credit, the federal tax credit is for U.S. companies that are engaged in qualified research activity. This still leaves a lot to the imagination and some confusion as to what exactly is a qualified research activity.
Qualified research, dictated by Internal Revenue Code 41, is research that is undertaken for the purposes of discovering information that is technological in nature, and the application of which is intended to be useful in the development of a new or improved business component for the tax payer.
In other words, qualified research activities are those that relate to the development of new or improved products, processes, formulas and software.
The credit was enacted in 1981 and has changed several times since. The most recent change in 2015 made the credit permanent and able to offset the alternative minimum tax as well as federal payroll tax for some qualifying businesses. The credit typically ranges from 4 to 7 percent of eligible expenses for new and improved products and processes.
Eligible costs include: U.S. employee wages, cost of supplies consumed in the development process, pre-production testing costs, and costs associated with third-party contractors used in the development process.
Companies that are, or have in the past, invested in the creation of a new or improved business component, and have expenditures similar to the ones described above, could potentially qualify for this federal tax incentive.
The future of the R&D Tax Credit looks bright with increased attention being seen at the federal and state levels. Most recently, The PATH Act of 2015 not only expanded but permanently extended the R&D tax credit federally.
New Hampshire is seeing an increased focus toward innovation and startups, which provides widespread application for the R&D tax credit. The best time to integrate this strategy into a new business is now, providing a solid foundation as the credit continues to grow.
Max Vignola is assistant director of tax /director of R&D Services at Bedford Cost Segregation. He works with clients to educate them on the benefits of the R&D Tax Credit and develop an action plan for qualifying companies.