IS THERE A LIMIT TO THE AMOUNT OF THE RESEARCH CREDIT THAT CAN BE CLAIMED?

Author | Source Advisor

2 May, 2020. 6 min read

There is no set maximum amount that you can claim.

If the federal R&D credit can’t be used immediately or completely, then any unused credit can be carried back one year or carried forward for up to 20 years. Each state has its own carryover rules.

While tax reform, often referred to as the Tax Cuts and Jobs Act (TCJA), introduced many new changes for businesses, the R&D tax credit continues to provide reliable opportunities for reducing income tax liabilities—often saving companies hundreds of thousands of dollars.

The R&D tax credit 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.

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. Research & development tax credit industries include manufacturing, software, engineering, financial services, and many others.

If you’re improving or enhancing products and processes to remain relevant and profitable, you may qualify for R&D tax credits. Often times, 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 credits. 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 Manufacturing & Distribution:

This company specializes in developing complex and highly sophisticated electronic products including emergency response systems, communications systems, data networks, digital media hubs, and various technologies for use in urban environments. The company may also design and develop the internal componentry of its products including mechanical, electrical, and software systems. Research is performed by designers, mechanical and electrical engineers, software developers, computer engineers, CNC programmers, CAD designers, machinists, quality control and technicians.

The company begins each project with brainstorming sessions to determine feasibility and achieve a basic framework for the concept. At this stage, hypotheses will be developed as to what the company believes will be the most likely development track. The project then moves to the detailed design and engineering phase where the team will address form, fit, material, and performance issues. Calculations and computer models are evaluated and modified as necessary. Issues with configuration, material composition, and manufacturability are also addressed. For example, how electronic components fit together on a printed circuit board is a major area of redesign requiring the evaluation of different design alternatives in order to manufacture successfully.

Prototypes are developed to evaluate various configurations of components and their resistance to environmental conditions such as vibration or heat. The primary materials used during the prototyping process include structural metals, circuit boards, PC boards, transistors, circuits, wiring, plastics, and the housing. Oftentimes, multiple prototypes or samples are constructed and tested to validate the  alternative or experimental designs. Testing of gain and bandwidth are also included for performance and reliability. It is common for tests to fail as circuitry, power, and electronic components are modified, and the testing environment is activated in an attempt to deliver new products to meet customer specifications. This development process is repeated until a successful component is designed and manufactured.

RESULTS SPEAK FOR THEMSELVES

This $40 million manufacturing company generates over $415,000 of annual R&D Tax Credits with R&D expenses of about $6.5 million