For a number of companies, research and development is a critical aspect of their business. Research and development (R&D) can lead to the introduction of new products, bring about improvements to existing products and establish more efficient and effective methods of production. Aside from all these exciting things that can help grow a business, some costs can be offset with tax incentives.
Welcome to the world of R&D!
What types of incentives are available to companies?
Businesses can choose to deduct or capitalize R&D expenditures. Many taxpayers choose to deduct as much as possible in the current year, so they elect to treat R&D costs as current business expenses. The amount of expense deducted reduces taxable income on the tax return, much like other business expenses. A business can also capitalize and deduct these costs over a five or ten year period. So you have options.
Federal and state R&D credits are also available in addition to the expense deduction. Many companies find the R&D credits to be an attractive benefit. The net federal R&D credit is typically between 5% and 7% of eligible expenses (more on that later), and the state benefit can exceed this. Just remember, you have to file for the federal and state credits separately on the applicable tax returns.
A business can calculate the credit for all open tax years, but it may involve amending tax returns. This is still something you may want to consider if there has been an increase in R&D spending over the last several years.
So what exactly qualifies as eligible R&D activity?
The definition of what fits in this category is quite broad making the credit accessible to businesses in many different industries. A few examples of the types of activities that typically qualify include:
- Development of new, improved or more reliable products, processes and techniques
- Designing/modifying production equipment
- Molds, tooling, dies, fixtures, jigs design/modification
- Raw materials research
- Development or testing of new concepts and technologies
- Development or customization of software
- Automation and/or streamlining of internal processes
Who qualifies for R&D tax incentives?
Businesses that qualify generally employ technical personnel, such as engineers, designers and developers. The credit can offset taxable income (or payroll tax if the business qualifies), whether the business is established or is a startup company.
Recent developments in R&D tax incentives make it more available to a larger population. Some of these include:
- The federal R&D credit was made permanent in December 2015. This means it’s around for good!
- Beginning in 2016, businesses with less than $50M in gross receipts can use the federal R&D tax credit to offset Alternative Minimum Tax (AMT).
- Businesses less than five years old and with less than $5M in gross receipts can use R&D tax credit to offset quarterly payroll taxes in 2017.
- Final regulations enhance the ability to include prototype component costs and software development expenditures in the credit.
The moral of the story?
If you think all this sounds complicated, you’re right. It can be complicated, but also a real benefit for your business. What’s important is to talk to your tax advisor and ask these types of questions. If they don’t know, make sure you track down someone knowledgeable in this area (cough — us).
A knowledgeable advisor should be able to help you set up a plan to calculate and file for the R&D tax incentives, as well as ensure you have the documentation you need.
Shameless plug: We can help you with all of the above. Just ask.