By Richard J. Beamish
Aug. 15, 2013
For decades, many businesses have overlooked the Research and Development Tax Credit (R&D tax credit), assuming its benefits were exclusive to large manufacturing, biotech and pharmaceutical companies. But regardless of the size, revenue or industry of a business, new innovations and pioneering activities can be classified as research and development, resulting in tens to hundreds of thousands of dollars in tax savings. With its recent extension through 2013, as part of the American Tax Relief Act (ATRA), businesses can now become acquainted with this lucrative tax credit and explore the benefits they could be eligible for.
What is the R&D tax credit?
The R&D tax credit was established by Congress as part of the Economic Recovery Tax Act of 1981. Its intent, which it still is today, was to encourage research and development activities among businesses through tax incentives.
The benefits of the tax credit can be seen in the numbers. Research conducted by the Wall Street Journal reports that the extended R&D tax credit helped boost profits by more than 10 percent for several dozens of companies that reported a year of benefits from the tax credit in the first quarter of 2013. Some companies saw profitability of more than 30 percent as a result of the tax credit. This can happen to any business that is proactive in discovering how it qualifies for the tax credit and how to appropriately file for the credit on its tax returns.
Does your business qualify for the R&D tax credit?
For research to qualify, it must be undertaken to discover information that is technological in nature and intended to be useful in the development of a new or improved business component. That may include research on new products, improvement of existing products, and development of more reliable and cost effective processes. Additional qualifying activities include, but are not limited to:
Designing tools, jigs, molds and dies
Improving and/or building manufacturing facilities
Developing prototypes or models
Testing new concepts and/or sourcing new materials
Quality certification testing
Improving products, processes or formulas
The R&D tax credit is designed to cover the three basic categories of expenses:
Wages for employees involved in research activities
Cost of supplies consumed during the research
Costs associated with contracting with an outside party to conduct research on your business’ behalf (generally limited to 65 percent of the cost).
What is the value of the R&D tax credit?
The R&D tax credit is not just a tax deduction - it’s an actual dollar-for-dollar credit against taxes owed or taxes paid. There are two options available to calculate the R&D tax credit:
Regular Research Credit
The regular credit calculation (RRC) uses current-year qualified research expenses and complex base amounts, including prior year research expenditures and gross receipts. It is an incremental credit equaling 20 percent of a taxpayer’s current-year qualified research expenses (QREs). This is determined by applying the taxpayer’s percentage of gross receipts spent on QREs historically (known as the fixed-based percentage) to the four previous years’ average gross receipts.
Alternative Simplified Credit
For companies unable to generate a credit under the RRC method, the alternative simplified credit (ASC) is available. Effective since 2007, this option was established as the name suggests, to “simplify” the calculation process. ASC does not include gross receipts. Instead, this credit calculation equals 14 percent (for tax years beginning on or after Jan. 1, 2009, and 12 percent for years prior 2009) of the QREs for the taxable year exceeding 50 percent of the average QREs for the three taxable years preceding the credit determination year. If the taxpayer does not have any QREs in any of the three prior years, the credit equals 6 percent.
How to start the process
The R&D tax credit has many benefits, but it is wise to get expert help to navigate the complex calculations alone. R&D tax specialists can guide you through the complexities of filing the tax credit and help you reap the most benefits possible.
Richard J. Beamish, CPA, MST, is a Research and Development Tax Shareholder at Doeren Mayhew, a globally recognized, top 100 U.S. CPA firm that goes beyond traditional accounting to help mid-sized companies grow and prosper. Doeren Mayhew is based in Troy, Mich. For more information contact Beamish at (248) 244.3005 or [email protected].