The Research and Development (R&D) Tax Credit is one of the most significant domestic tax credits serving as a substantial tool for maximizing a company’s cash flow and bottom line. Despite the fact that the R&D credit has been available since 1981, less than a third of eligible companies recognize that they qualify for the credit. Every company improves products and processes to remain competitive and the government rewards them for their innovation through this tax benefit.
To qualify for the credit, your firm must develop a new or improved business component based on technology grounded in the physical sciences (such as engineering principles, biology, chemistry, and/or computer science). There must also be uncertainty associated with the project, and a process of experimentation and testing to resolve the uncertainty.
To qualify for the R&D Tax Credit, you will need to meet three cost components to qualified research:
- Expense of direct wages;
- Expense of supplies consumed; and Cost of contract research
- Proper documentation is important in avoiding and dismiss an audit.
Credits for qualified activities are available in addition to deductions. The credit is a dollar-for-dollar cash offset against your taxes and can be significant if properly pursued.
Companies of all sizes in a wide range of industries throughout the United States have used the R&D tax credit. According to a report released by the R&D Credit Coalition, an advocacy group:
- 17,700 public and private companies claimed research tax credits for a total of $6.6 billion in tax breaks
- Firms in all major industries claim the R&D credit; principal industries include manufacturing, professional, scientific and technical services and information sectors
- States with the most companies reporting R&D activity include Florida, California, Texas, Massachusetts, Pennsylvania, New York, and Michigan
Identifying Qualified Research Activities (QRAs)
The following four criteria, known as the Four-Part Test, MUST be satisfied and documented on a contemporaneous basis. Each QRA or QRE must satisfy these four criteria in order to be included in the credit:
1. Technological in Nature
The activity performed must fundamentally rely on principles of:
- Physical or Biological Science
- Computer Science
2. Permitted Purpose
The activity must relate to new or improved business components:
3. Process of Experimentation
The taxpayer must engage in an evaluative process that is capable of identifying and evaluating more than one alternative to achieve a result. This may include modeling, simulation or a systematic trial and error methodology.
4. Elimination of Uncertainty
The activity must be intended to discover information to eliminate uncertainty concerning the capability, method or design for developing or improving a product or process.
- Research after commercial production
- Adaptation to a particular customer without completing the aforementioned 4 Part Test
- Duplication (i.e. reverse engineering)
- Funded research
- Management activities, efficiency surveys, and market research
- Routine data collection & quality control
- Research conducted outside of the United States and its territories
About Engineered Tax Services:
Our R&D studies dig deep for better credits. We perform a study that digs much deeper into the fundamentals of your business activities – incorporating operations, engineering, financial, and tax expertise that results in more credits and meticulous documentation that is necessary to support your activities, costs, and credit. There is a direct correlation between the amount of your defensible credit and the expertise of the advisor performing the tax credit study.