If your company is developing new or improved business components, including products, processes, software, techniques, formulas, or inventions, that result in new or improved functionality, performance, reliability, or quality, it’s time to take a look at the R&D (research and development) tax credit.
What is the R&D Credit?
There are R&D credits available at both the federal and state levels. The R&D credit is a one-to-one dollar tax savings that directly reduces your company’s tax responsibility. Business owners should claim all costs related to R&D – there is no limit on the amount of expenses and credit that can be claimed in a year. If you’re a startup, you may be eligible to apply the R&D tax credit to your payroll for up to five years.
The R&D credit is also retroactive, in some cases. Depending on when you filed your business return, you may be able to claim R&D credits for three prior open tax years.
Is My Manufacturing Company Eligible for the R&D Credit?
Is your company:
- Devoting time and resources to creating new or innovative products or processes?
- Improving existing products or processes?
- Developing patents, prototypes, or software?
- Hiring designers, engineers, scientists, etc.?
If you can answer yes to any of those questions, you may be eligible for the R&D credit.
It’s a common misconception that a company has to be focused on R&D to qualify for the credit, but that isn’t the case. It’s the activities your company is performing that makes the costs associated with those activities eligible for the credit. Further, the designers, engineers, scientists, etc. you have on staff don’t have to be degree-holding designers, engineers, scientists, etc. Whoever is performing the R&D activities, both employees and third-party contactors, can be included in the costs claimed for the credit.
The R&D credit is much broader than you may realize. It applies to the development of new or improved business components, including products, processes, software, techniques, formulas, or inventions, that result in new or improved functionality, performance, reliability, or quality. It’s very important to point out that your company doesn’t need to be producing anything new to your industry, it just needs to be new to your company and pass the four-part test below.
How Can I Tell if My Activities Are Eligible for the R&D Credit?
While there is a broad range of activities and expenses that can be claimed for the R&D credit, they all need to meet the criteria of a four-part test put forth by the IRS:
- Permitted purpose: The activity must be for a new or improved business component’s function, performance, reliability, quality, or composition.
- Technological in nature: The activity must fundamentally rely on principles of physical, biological, computer, or engineering sciences. No need to create or expand on an existing principle, just rely on an existing principle.
- Elimination of uncertainty: You must intend to either discover information or eliminate uncertainty regarding the capability or method for developing or improving a business component or process, or the appropriateness of the product design, with your activity. What technical challenges did you anticipate when you started the research for your R&D process and worked to overcome?
- Process of experimentation: You must be able to demonstrate to the IRS that you evaluated one or more alternatives for achieving your goal. This can be done through modeling, simulation, systemic trial and error process, etc.
How Can I Claim the R&D Credit?
Like most tax credits, you’ll need documentations for your activities like:
- Payroll records for employees or contractors executing the R&D activities
- General ledger expense details for the R&D activities
- Project lists
- Project notes
- Lab results
- Emails and other company documents produced throughout the course of business
Credible employee testimony will also help make the basis for an R&D claim.
Good News for companies Subject to AMT
If your company is subject to AMT (alternative minimum tax) and is an eligible small business (ESB), for tax years beginning after January 1, 2016, you can offset regular taxes and AMT using the R&D tax credit.
Corrigan Krause Specializes in Manufacturing Accounting
If you’re unsure about your eligibility for the R&D credit, the Manufacturing Services group at Corrigan Krause can help. Email Tommy Sustar at thomas@corrigankrause.com or info@corrigankrause.com for more information and sign up for our Manufacturing Services newsletter here.