R&D Tax Credit FAQ
A company may qualify for the R&D tax credit if they have invested time, money and resources toward developing new products or improving existing products; developing new materials; building and testing prototypes and models; developing new or improved software applications; testing new concepts; developing or improving manufacturing processes; experimentation and more. Any company trying to improve what they do, be more competitive, reduce costs or increase market share will have qualifying activities. Together, we will determine the extent of the qualifying activities, the amount of the resulting tax credit, and whether the company can utilize the credits once they have been identified and documented.
The first step is to evaluate your ability to utilize the credit. For years prior to 2016, the R&D tax credit can be used to reduce regular tax down to the minimum tax levels. Beginning in tax year 2016, there are two important enhancements:
- The R&D tax credit can be used to offset alternative minimum tax for eligible small businesses. An eligible small business is defined as either a non-publicly traded organization, a partnership or sole proprietorship whose average gross receipts for the prior three years is less than $50 million.
- Start-up companies are able to use the research credits against payroll tax. A start-up company is defined, with respect to any taxable year, as a corporation (including an S corporation) or partnership with gross receipts of less than $5 million for the taxable year and no more than 5 years of gross receipts history.
Unused credits carry back one year and then carry forward for up to 20 years.
Once it is determined there is sufficient tax available for your company to benefit from the credit, it is time to proceed to the next step which includes determining the qualifying research expenditures and the resulting tax credit.
A company can go back to any open tax year, which typically is the prior three years. For example, if you have a December 31 year-end and you filed your 2013 tax return on September 1, 2014, your 2013 tax return is open until September 1, 2017.
In 2003, the definition of Qualifying Research Activities was clarified through regulations and includes many day-to-day activities. If you are conducting engineering activities that are new to you as a company and there is risk associated with the success of the outcome, this may qualify as R&D.
The credit is based on an increase in spending over a base amount. If you had research activities in 1984-1988, this would be considered your base period, and you would need information from this time frame to compute the credit using the regular credit method.
There is an alternative simplified calculation method. This method allows companies that have not filed their tax returns to use the prior three years as their base calculation. Each year you can elect the method that is most beneficial. This election can also be made on an amended return if no election was previously made.
Many of our clients have this concern at the outset of the project and are surprised at how little disruption the process causes. In general, your personnel will spend 20 – 30 hours spread over several people (15 – 45 minutes from each person). Clients that are better organized and willing to assist us in upfront planning generally spend less time.
SourceHOV | Tax’s experience has been that less than 3% of our clients are selected for audit. If you are selected for audit, having the proper documentation and support is critical, and the SourceHOV | Tax approach to R&D tax credit projects facilitates this.