Research and Experimentation Tax Credits

What is the Research Tax Credit?

Formally known as the Research and Experimentation Tax Credit, the research tax credit, or R&D credit, is a tax incentive given to companies who are in the business of developing products that are lighter, faster, more durable, less expensive, more reliable or more precise.

The Research Tax Credit isn’t just for high-tech manufacturers or medical researchers. In fact, more companies than you would think qualify for the credit, including those in the business of product development, including manufacturing processes, software development, environmental improvements and quality enhancements of almost any type of product.

Also, companies that invest significant resources to design and build parts, equipment or infrastructure according to customer specifications.

In many cases, if a risk of loss exists relating to the designs, these costs may qualify for the credit as well.

QUALIFYING COMPANIES INCLUDE:

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Aerospace and defense
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Semiconductor
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Software
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Manufacturing
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Life sciences, including pharmaceutical and medical sciences
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Construction and engineering
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Food service and processing
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Chemicals and plastic
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Many others (retail, financial, oil and gas, telecom, automotive, etc.)

QUALIFYING EXPENSES INCLUDE:

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Payroll (includes Box 2, W-2 wages for all employees involved in the research, including supervisory and support staff)
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Supplies consumed in the process
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Certain subcontractor expenses

The four-part test

To qualify for the Research and Experimentation Tax Credit, your R&D expenses must meet each of the following criteria.

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01

To qualify for a research tax credit, a company must be able to demonstrate that a process was used to evaluate alternatives in order to achieve the desired result. This could be through modeling, simulation, systematic trial and error, or other methods.

A pharmaceutical company could use a series of trials to find the best chemical formula for a new drug, or a software developer might run A/B tests to assess user experience.

Process of experimentation
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The process of experimentation described above must rely on hard sciences and data. This part of the test is formally referred to by the IRS as the "Discovering Technological Information Test."

"In order to satisfy the technological in nature requirement for qualified research, the process of experimentation used to discover information must fundamentally rely on principles of the physical or biological sciences, engineering, or computer science. A taxpayer may employ existing technologies and may rely on existing principles of the physical or biological sciences, engineering, or computer science to satisfy this requirement."

What does this mean? You don't qualify for a Research Tax Credit just because you sent out a SurveyMonkey poll about your product.

Technological in nature
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The qualified purpose requirement, also known as the Business Component Test, requires businesses to show that they conducted the research in order to create a new or improved product or process. For companies seeking to improve an existing product, the goal of the research should be to increase performance, function, reliability or quality.


The IRS defines a business component as any product, process, computer software, technique, formula, or invention, which is to be held for sale, lease, license, or used in a trade or business of the taxpayer.


Many companies attempt to qualify for the R&D Tax Credit for their general research and experimentation work, but the IRS requires taxpayers to tie the research to a specific business component.

Qualified purpose
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Was the research conducted to determine if the new product or process would be feasible for future development, and how? If the anwer is yes, it likely satisfies this portion of the four-part test.


The IRS says research and development costs qualify "if they are for activities intended to discover information that would eliminate uncertainty concerning the development or improvement of a product. Uncertainty exists if the information available to the taxpayer does not establish the capability or method for developing or improving the product or the appropriate design of the product."


In other words, a company can't claim a Research Tax Credit for their work developing a product they know without a doubt will be successful.

Uncertainty

Frequently Asked Questions about Research Tax Credits

DOES MY TAX PREPARER ALREADY DO THIS?

While many tax preparers understand the basics behind the Research and Experimentation Tax Credits, it takes a professional who works in this field on a daily basis to truly understand all the rules and complexities that govern the R&D Credit, both at the Federal and state levels. We will actively partner with your CPA to ensure proper use and maximization of your R&D Credits.

Do I need to amend my tax return to use the R&D Credit?

Perhaps. If you are seeking the R&D Credit for the first time as a company, and you have been performing R&D activities for several years, it may benefit you to calculate your credits for prior tax years to take full advantage of the study.

    How much does it cost and how much will I save?

    The cost of an R&D study is based on time and expenses. The more complex the situation, the more time and expense that will be incurred. In general, the benefits of the study end up being three to six times the cost. Fees paid for an R&D study are also tax deductible.

    How do I get started?

    Contact Veracity today at tax@taxveracity.com or call 888.968.4094 to request your no-cost estimate. You can also book a free consultation today. 

     

    You earn. Your client saves.

    Ready to get started?

    Because Research Tax Credits can be a highly lucrative tax strategy, the IRS applies extra scrutiny to companies who take advantage of the credit. Due to this extra scrutiny, the qualitative and quantitative aspects of a Research Tax Credit claim must be well documented and follow tax law.

    Veracity’s R&D professionals are industry experts who have years of experience in performing these studies. Veracity’s leaders and staff have the depth of knowledge and expertise required to perform the complex tasks associated with a proper R&D study and the tax expertise to help you maximize the benefits.

    Book a no-commitment introductory call today.