Businesses across the country receive tens of thousands or hundreds of thousands of dollars each year with the Research and Development Tax Credit. But there are also several businesses losing out on the tax credit because they simply don’t know what qualifies.
So, how do you know if you qualify for R&D Tax Credit?
What you should know about the R&D Tax Credit
For years, big businesses have received a substantial portion of the R&D tax credit dollars, but small and mid-size businesses deserve their fair share. After all, they represent more than 90% of businesses in the U.S.
Fortunately, in 2015, the federal government passed the Protecting Americans from Tax Hikes Act (PATH Act) allowing those small and mid-size businesses to more easily qualify for the credit. Now, every successful company is potentially eligible for the R&D Tax Credit. Depending on the business, even your day-to-day operations may qualify. It’s just a matter of having a total understanding of what is and isn’t allowed with this credit.
The R&D Tax Credit is a dollar-for-dollar reduction against taxes currently owed and previously paid. It is usually available for the current year and previous three years. However, a business can take the credit for any open tax year. Additional years may be available if the business is in a net operating loss or alternative minimum tax position. And federal tax credits can carry forward for twenty years.
Note: The R&D tax credit is not to be confused with the R&D Tax Deduction.
What Types of Businesses Can Qualify?
Contrary to popular belief, this is not limited to companies in the high-tech, biotech, and pharmaceutical sectors. The R&D Tax Credit can apply to a variety of industries including:
- Manufacturing (which accounts for more than 60% of all claimed credits)
- Software development
- Quality assurance
- Information technology
- Wholesale/retail, professional
- Scientific and technical services
- Insurance / finance
R&D: Here to Stay
For years, the R&D Tax Credit was subject to periodic extensions, sometimes retroactive, which caused concern over its long-term viability. But that all changed in December 2015, when the Protecting Americans from Tax Hikes Act (PATH Act) made the tax credit permanent.
In addition to the permanency of the credit, it’s clear that additional incentives are encouraging companies of all sizes — particularly small business owners — to invest in improving their products and process to be more competitive globally.
What Activities Qualify for R&D Tax Credit?
Many common manufacturing activities actually qualify for R&D Tax Credit, so the question is whether or not your company does any of them.
Does your company…
- manufacture products?
- develop new, improved, or more reliable products/processes/formulas?
- develop prototypes and models including computer generated models?
- design tools, jigs, molds, and dies?
- develop or apply for patents?
- perform certification testing?
- conduct testing of new concepts and technology?
- develop new technology?
- attempt using new materials?
- perform environmental testing?
- add new equipment?
- develop or improve production/manufacturing process?
- develop/improve software or hardware?
- improve or build new manufacturing facilities?
- automate/streamline internal processes?
Or does your company hire outside consultants/contractors to do any of these activities? If so, you may be eligible for this credit.
The 4-Part Test
Ultimately, the work you do must pass the 4-Part Test in order to fully qualify for the R&D Tax Credit. The 4-Part Test includes:
- Permitted Purpose: The activity must be geared toward creating or improving an existing product, process, technique, software, formula, invention, or patent. It can also be an improvement to functionality, performance, cost, quality, or reliability.
- Technological in Nature: The activity must rely on hard sciences — physical sciences, biological sciences, computer science, or engineering.
- Elimination of Uncertainty: You must be able to demonstrate that you tried to eliminate uncertainty regarding the development or improvement.
- Process of Experimentation: You must demonstrate that you evaluated alternatives, confirmed hypotheses through trial and error, tested, modeled, or refined or discarded hypotheses.
R&D Tax Credit Qualifying Costs
When it comes to identifying R&D Tax Credit qualifying costs, there are three things you need to consider:
- Wages: Wages paid to an employee conducting R&D-qualifying activities can be claimed through your tax credit. For example, if you have an employee, who makes $100,000 a year, spending 40% of her time working on identified R&D activities, 40% of her wages are eligible for the tax credit.
- Supplies: Any supplies consumed while completing qualifying research activities can count toward your tax credit. Some examples include parts for prototype products, experimental production tools, and chemicals used during testing.
- Contractor Research: If an outside business or person is conducting qualifying research activities for your company, you can claim 65% of the money paid or incurred by your company toward the credit. Contractors are likely to include engineers, subcontractors, and test labs.
When determining whether your business qualifies for the R&D Tax Credit, it’s a good idea to seek professional help from someone who knows your industry and understands the law because it’s equally important to know what can and cannot be included in your reduction.