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Fifty years ago, the world was riveted to their television sets to see history in the making when the Apollo 11 crew touched down on the moon. Where would technology be today without the ingenuity and courage of the NASA space program?
Since that famous moonwalk, new inventions and advanced technologies have been developed that make life easier, help us live longer and healthier lives, allow us to communicate more easily as well as entertain us. Products such as cellular phones, scratch-resistant eyeglass lenses, CAT scanners, LED lighting, athletic shoes, foil blankets, ear thermometers, wireless headsets, artificial limbs, and the computer mouse are just a few of the wide array of products born from the knowledge gained during the space race and the cosmic exploration era that followed.
In 1981, the U.S. Government recognized that developing new and innovative products, fabrication processes and software systems was a costly undertaking for private industry. More importantly, Congress was concerned about our manufacturing base and the need to retain America’s position as the most technologically advanced nation on the planet, which resulted in the introduction of the Credit for Increasing Research Activities (a.k.a. “The R&D Tax Credit”). Its intended purpose was to provide a significant tax break to manufacturing companies that develop new or improve existing products, fabrication processes and software, and thereby strengthen the US economy.
What is the R&D Tax Credit?
- It is a dollar-for-dollar credit against taxes owed or taxes paid
- Federal and state research tax credits can amount to as much as 20% of the costs incurred in research activities
- Federal R&D tax credits can be carried back one year or carried forward 20 years
- Research tax credits can be claimed retroactively for up to 3 prior years
- Allows eligible small businesses to offset payroll taxes up to $250,000 per year
- Does not distinguish between a prototype’s failure or success
Does Your Business Qualify?
Regardless of industry, your company’s activities must meet the Four Tests as outlined in IRC §41 to qualify for the research and development tax credits:
Business Component
The activity must relate to a new or improved business component’s function, performance, reliability, quality, or composition. You don’t necessarily have to discover an innovation or advancement that’s new to your industry, only what may be innovative or new to you and your company’s processes or products.
Technological Uncertainty
The activity must involve the elimination of uncertainty. An activity entails uncertainty if the taxpayer did not know one or more of the following at the outset of the project
- Whether the desired results could be achieved
- The specific means of achieving the desired result
- The appropriate design of the business component being developed
Process of Experimentation
“Substantially all” of the activity must involve a “process of experimentation” involving more than one possible approach toward achieving the desired result, where the capability or method of achieving the result is uncertain at the outset of the activity.
Technological in Nature
The activity performed must fundamentally rely on principles of physical sciences, biological sciences, computer science, or engineering.
How to Claim the Federal Research Tax Credit
The taxpayer must file IRS Form 6765 with the company’s corporate return. In addition, the taxpayer must document its qualifying research expenses and development activities.
Seek Professional Advice
The R&D tax credit is a valuable opportunity to save tax dollars and increase cash flow. Like most IRS tax regulations, computing the R&D tax credit can be complex and documenting the expenses and qualifying activities can be challenging. If you think your company might be performing work that qualifies for the R&D tax credit, contact us for a no-cost assessment.
Source Advisors is a team of financial specialists and experienced engineers that, for more than 30 years, has been helping companies such as yours identify and document qualifying research activities and expenses. We seamlessly work with your CPA firm to maximize the tax benefits.
