Over the past 25 years, the Research and Development Tax Credit has been an elusive target for many businesses. Since its creation in 1981, the credit has died and been resurrected at least 11 times by Congress but never made permanent. Determining qualifying expenditures and the baseline for calculation would make the best business owner cringe. But armed with professional tax help, fighting the red tape can be a worthwhile endeavor for many businesses.
Private industry expenditures for research and development have increased to about two-thirds of national R&D spending, as the government’s portion has declined, from 1.92 percent of GDP in 1964 to 0.80 percent of GDP in 2004, according to the Manufacturing Council. American manufacturers, who account for 14 percent of U.S. gross domestic product, claim about 60 percent of the credits.
While research and development is often considered the domain of large companies, smaller businesses have more to gain, as the value of the R&D credit as a percentage of their assets can be as high as 9.4 percent. Of the 16,000 businesses using the R&D credit, more than 4,500 companies have assets of less than $1 million.
The IRS defines R&D expenditures as those “incident to the development or improvement of a product,” including the costs and attorney’s fees associated with obtaining a patent. The IRS definition of “product” includes formulas, inventions, patent, pilot models, processes and techniques. Excluded expenditures include quality control testing, advertising and promotion, consumer surveys, efficiency surveys, management studies, research for literary, historical or similar projects, and the acquisition of another’s patent, model, production or process.
The next hurdle is figuring out exactly how much tax credit the business has coming. Businesses must first determine their base amount of R&D expense, a calculation probably best done by a tax professional. The business can claim 20 percent of R&D expenses over that base amount, which will vary from business to business. The work must be done in the U.S. for U.S. research and development.
In 1996, Congress passed the Alternative Incremental Research Credit (AIRC), intended to help companies with significant R&D expenditures who did not qualify for the credit due to economic circumstances during the base period. The amount of the AIRC is typically less than the regular R&D credit.
Businesses may be able to go back as far as three years in claiming the R&D credit. Again, a tax professional can help determine if you meet IRS criteria for doing so.
Utilizing the R&D tax credit can result in “found money” for businesses, allowing investment in further research and development or other business growth activities. Your tax professional can help you capture the elusive beast, and your financial professional can help you decide what to do with it.
Any tax or legal information provided here is merely a summary of our understanding of some of the current tax regulations, and is not exhaustive. Investors must consult their tax advisor or legal counsel for advice and information concerning their particular situation.