The research and development tax credit is a general business credit that was originally introduced in the Economic Recovery Tax Act of 1981 to stimulate research and development in various industries. The credit can be claimed by any company that designs, develops, or improves product processes, techniques, formulas, inventions, or software. Common industries eligible for the credit are manufacturing, software development, engineering, architecture, pharmaceutical and more recently, financial service companies. Since 1981, the research and development credit has been expired and extended several times; however, the credit was made permanent in 2015 by the PATH Act. The PATH Act also provided several enhancements to the R&D tax credit, such as providing start-up companies the ability to offset their payroll tax expenses by the credit, as well as allowing qualifying small businesses to use the R&D credit to offset alternative minimum tax (AMT). The newly permanent research and development credit provides a great opportunity for businesses to realize tax savings while continuing to grow and expand their business.
The research and development credit is calculated based on the amount of qualified research expenses that a company incurs during a tax year. Qualified research expenses are costs that a business incurs in the trade or business for research and development activities producing information to help eliminate uncertainty about the development or improvement of a “business component.” The term “business component” includes formulas, inventions, patents, pilot model, process, techniques or similar property. Expenditures deemed to be qualified research expenses are generally limited to wages, supplies and contract research expenses.
Historically, many start-up companies and small businesses have forgone the opportunity to take the R&D credit due to their lack of ability to utilize the credit. Whether it has been due to start-ups not having taxable income for the R&D credit to offset or small businesses being confined by AMT; the credit was not historically useful to all companies that qualified for the credit. Starting in 2016, the historical limitations to start-ups and qualifying small businesses have been eliminated. Accordingly, there are many innovative businesses that have a new opportunity to increase their cash flow by utilizing the R&D tax credit in 2016 and beyond. The tax advisors at GBQ are more than willing to discuss the nature of your business and the eligibility of the research and development credit.
Article written by:
Ashley Neel, CPA