This past week I was asked by one of our long-time clients to look into potentially claiming the Research & Development (R&D) tax credit under Internal Revenue Code Section 41. I must say, the criteria for being able to claim this credit is quite complex. For those innovative companies who are unsure if they qualify, below is a quick “primer” on the basics:
- In general, the activities the company performs must be technological in nature and be used for developing a new or improved product or process.
- If this description fits what your company is doing, the next step is to pass the quite complex IRS’s four-part test. Here are the basics of the tests:
- Discovering Technological Information Test – the company’s activities must be technical in nature and intend to eliminate uncertainty concerning development or improvement of a Business Component
- Business Component Test – the company’s activities must intend to apply the information discovered to develop a new or improved component of the taxpayer. This includes the creation of a new or improved product, process, computer software, technique, formula, or invention, which results in the increases performance, function, reliability, or quality.
- Process of Experimentation Test – the company develops a process designed to evaluate one or more alternatives of achieving a result, or appropriate design of that result, that is uncertain as of the beginning of the activities.
- IRC Section 74 Qualifying Expenditures Test– the expenditures made by the company must be incurred in connection with the trade or business of the taxpayer and represent a research and development cost in the experimental or laboratory sense. This means that the activities must be intended to discover information that would eliminate uncertainty concerning the development or improvement of the product.
- The types of the companies that would usually qualify perform the following tasks:
- Develop processes, patents, formulas, techniques, prototypes, or software
- Improve or re-design existing products
- Develop time and resources to creating new or innovative products
- Develop patents for intellectual property
- Frequently hire scientists, designers, or engineers
- Non-qualifying activities typically include, but are not limited to:
- A customer wants you to improve its specific product or service
- Research is conducted after the beginning of commercial production
- Software created for internal use only
- Purchasing a patent
As you can see, there are a great deal of complexities to determine if your company is eligible to claim this tax credit. If you are able to claim the credit, the savings can be substantial if your company has income. If your company doesn’t have income, you may be eligible to offset a portion of your companies’ FICA taxes under the PATH Act provisions. If you believe you may qualify or have questions please feel free to contact me directly!