The federal and state governments provide an incentive to companies that perform research and development (R&D) activities int he United States in the form of tax credits. Many companies do not realize they qualify for R&D tax credits, which is one of the most generous tax credits available and provided permanent tax savings.
The Freed Maxick R&D tax credit specialists can assess whether your company is eligible for R&D tax credits for current and prior open tax years.
If your company engages in any of the following activities, then you may qualify for R&D credits:
- Develop new or improved products or processes
- Improve manufacturing or production technologies, processes, techniques or procedures to increase yield, reduce waste and byproduct, improve safety, improve energy
- efficiency or comply with regulatory requirements
- Advance the design of existing products or processes
- Correct significant design defects, obtain significant cost reductions, or enhances function
- Design, development and test pre-production prototypes and models
- Software development
- Implementation of automated processes or robotics to increase production efficiency
- Design tools, jigs, molds or dies
- Architectural or engineering services
Certain criteria must be met
The following four-part test is applied to determine whether you have qualifying activities:
1. New or improved business component – The activities must relate to a new or improved product or process that improves the components function, performance, reliability or quality.
2. Eliminate uncertainty – The activities must be undertaken to eliminate uncertainty concerning the capability to develop, method of developing, or appropriate design of a new or improved business component.
3. Technological in nature – The activities must be intended to discover information that is technological in nature using a process of experimentation that relies on hard sciences (physical or biological sciences, engineering, or computer science). The information doesn’t have to exceed, expand or refine common knowledge of skilled professionals in their respective field of science or engineering. Further, it doesn’t have to be successful.
4. Process-of-experimentation – Substantially all of the activities must involve a process of experimentation to achieve the intended result. A process of experimentation requires the development of one or more hypothesis to eliminate technical uncertainty, testing and analyzing those hypotheses using hard sciences, and refining and discarding hypotheses.
The Path Act
In 2015, two new sets of published tax rules provided several favorable developments for U.S. taxpayers claiming these credits. Many taxpayers, including for example those who developed software interface for third parties to engage in business through the internet, could benefit from these rules.
Proposed treasury regulations, released on January 16, 2015, clarified the types of activities for developing Internal Use Software (IUS) that are eligible for the credit. In addition, the “Protecting Americans from Tax Hikes” Act (PATH Act) enacted on December 18, 2015 established laws that promoted the ability of most taxpayers, including start-up businesses, to claim the credit.
Under the PATH Act, the following provisions were enacted into law:
The Credit is Now Permanent – The R&D credit, which had expired for amounts paid or incurred after December 31, 2014, was retroactively reinstated and made permanent. Fiscal year taxpayers whose tax year ended in 2015 might want to file amended returns to claim the credit for amounts paid or incurred on or after January 1, 2015, and before the end of their fiscal year.
Certain Small Businesses Can Use the Credit to Offset Alternative Minimum Tax – Beginning with the 2016 tax year, eligible small businesses (ESB) and their owners can claim the R&D credit against the alternative minimum tax liability. An ESB includes partnerships, sole proprietorships, and privately held corporations whose average annual gross receipts for the three tax-year period preceding the tax year for claiming the credit does not exceed $50 million.
R&D credits determined for a partnership or S corporation are not treated as ESB R&D credits by any partner or shareholder unless that partner or shareholder also meets the gross receipts test for the tax year in which the credits are claimed.
Certain Small Businesses Can Use the Credit to Offset Payroll Tax – Beginning with the 2016 tax year, a Qualified Small Business (QSB) can elect to use the R&D credit against the employer’s old-age, survivors and disability insurance liability (i.e., FICA taxes). The election can be made for up to five tax years.