Author | Source Advisors
Is the R&D Credit a refundable credit?
The R&D Tax Credit is not refundable. If you don’t owe income tax or the credit is worth more than what you owe, you won’t receive a check from the IRS.
Most businesses will use the 20-year carryforward to apply their unused credit to future years’ taxes. Eligible small businesses can also opt to apply the credit towards their payroll taxes.
The Research and Development Tax Credit (R&D) is a tax credit for businesses of all sizes who conduct R&D in the United States. The R&D Tax Credit can be extended to a wide range of business and industries that exceeds far beyond scientists and research labs.
It was created to provide a tax incentive for U.S. companies to increase spending on research and development in the U.S. Each year more and more companies take advantage of the R&D Tax Credit . Additionally, in 2015, the Protecting Americans from Tax Hikes (PATH) Act, made the R&D Tax Credits permanent, while also extending the benefit to startups.
The activities that qualify for the R&D tax credit are the same ones driving growth in your business.
- Creating improved products, processes, formulas, software, and techniques
- Automating or improving internal manufacturing processes
- Designing tools, jigs, fixtures, and molds
- Integrating new equipment
- Development of data center, big data, and data mining tools
- Integration of APIs and other technologies
- Development of financial or pricing models
- Hiring outside consultants to perform any of the listed activities
- Manufacturing new or improved products
- Developing prototypes, first articles, models
- Evaluation of alternative materials
- Development of firmware
- Network hardware and software development and optimization
- Developing simulators
- Development of risk management systems
Ensuring that you understand the rules for qualification is an essential first step in claiming the R&D Tax Credit . This is normally done during a feasibility analysis, also referred to as Phase 1. R&D activities are explored and identified at a high level along with related qualified research expenses (QREs). This information is then used to estimate your federal and state R&D Tax Credit . Education is key and provides the ability to identify qualified activities and QREs so a more accurate benefit estimate can be determined.
The expenses that qualify for research activities within your company typically include employee compensation, materials, and contracted services. Various forms of documentation are sufficient to support your qualified expenses and may include payroll records, financial records showing supply or contract research expenses, and vendor invoices.
On average, companies are typically able to claim 7-10% of their qualified expenses as a federal R&D Tax Credit . For example, a single software developer, engineer, or lab technician who receives a W2 of $100,000 a year may generate a tax savings of up to $10,000.
Here’s an example of a case study for a company specializing in metal fabrication:
With over 40 years of experience in metal fabrication, this company continues to develop metal fatigue and failure mitigation techniques, serving the aerospace, automotive, biomedical, chemical, defense, energy, fitness, nuclear, oil & gas and rail industries.
While the company sometimes participated in product design, the majority of their R&D surrounded the development of manufacturing processes. Research efforts at this company fell within 3 different categories: stamping, molding, and tooling.
Process design entailed extensive research and development beginning with the examination of the component specifications followed by evaluating the various metal fabrication methods. The team included engineering, technicians, prototype assemblers, testers and quality assurance. They addressed form, fit, material, and performance issues. Calculations and computer models were evaluated and modified. Issues with configuration, material composition, and manufacturability were also addressed. The company developed four to five different prototypes for testing and analysis. Changes were made to the tooling, fabrication process and product design based on information discovered during the prototype construction stage. For example, prototypes were developed to evaluate various configurations of components and their resistance to environmental conditions such as vibration or heat. Multiple prototypes or samples were constructed and tested to evaluate alternative designs and process applications.
The prototyping process was a collaborative effort between the engineering group and the prototype assemblers. Prototype assemblers were responsible for creating and assembling prototypes based on the design requirements. The primary materials used during the prototyping process include various metals, circuit boards, PC boards, transistors, circuits, wiring, and plastics.
The cost of these materials was a qualified R&D expense. Next, the prototype designs were tested and validated against the intended product specifications. Design tests failed, which required the design to be further refined at either the component or prototype level. This testing process was a continual cycle between design and evaluation until the test requirements were met through design and process improvements. Prototypes were subjected to environmental testing, which normally included vibration and temperature tests. In addition, acceptance testing was performed once all other tests are passed.
To get to full production, the team developed custom fixtures, die casts, and tooling. These were also needed to produce prototypes and samples. The creation of a repeatable testing and quality control process that could scale with production loads was also designed. The final stage was the production part approval process (PPAP) prior to start of production.
RESULTS SPEAK FOR THEMSELVES
This company realizes annual federal and state R&D Tax Credit benefits of over $130,000.
Companies of all sizes and across many industries meet the federal government’s test for qualified innovation activities and can claim Research and Development (R&D) Tax Credits. However, many companies are not aware they qualify. There are thousands of companies that are leaving money on the table and not taking advantage of significant federal and state R&D Tax Credits.
Many people used to think R&D Tax Credits only applied to those that wear lab coats or create new best-in-class products. This is not the case – R&D Credit is much more expansive and far-reaching than most people realize.
In addition, research and development tax credit guidelines for software development have relaxed. All of this opens the door for companies that have not taken advantage of or maximized their R&D Tax Credits in the past.
These research & development tax credit industries now include manufacturing, software, engineering, financial services, and many others.
If you’re improving or enhancing products and processes to remain relevant and profitable, you qualified for R&D Tax Credits .
SEE IF YOUR STATE OFFERS R&D TAX CREDIT