Article written by:
Leah Rogers, CPA
Manager, Tax & Business Advisory Services
Jeff Waldeck, CPA
Senior Manager, Tax & Business Advisory Services
When it was originally enacted in 1981, the Research and Development (R&D) tax credit was intended as a temporary means of attempting to incentivize R&D amongst domestic taxpayers. Since then, the now-permanent tax credit has offered numerous companies an effective means of reducing tax liabilities for continuous technical development activities they were already performing.
In the midst of all of the economic uncertainty caused by COVID-19, many companies are seeking new means to improve cash flow and minimize expenses. The R&D credit can provide many businesses with a valuable tax benefit to help effectively operate in this new normal. While the credit has historically been underutilized, now has never been a better time to analyze whether a company may qualify for the credit. Furthermore, new development opportunities arise every day in response to COVID-19. Several companies have had to alter and adapt their business processes with rapid changes in order to effectively maintain operations. For example, businesses were forced to quickly enhance and improve their IT infrastructure to scale-up mobile and e-commerce functionality, as well as to improve remote-work capabilities. The time and expenses consumed during the development and research phases of implementing these changes may likely be captured as part of their R&D tax credit calculation. In addition, many manufacturing companies completely re-routed their normal production activities in order to aid in the supply of essential public resources, such as medical solutions or protective gear. The time and resources used to create new manufacturing processes, test new equipment, and improve current efficiencies can all lead to an enhanced R&D credit, and thus reduce tax liabilities.
So what activities will qualify for the R&D tax credit? In order to qualify for the credit, activities must meet a four-part test:
- Activities must be intended to develop a new or improved “business component” – i.e., a product, process, software, technique, invention, or formula. This could include the following:
- Researching a new product or process
- Developing a new product or process
- Improving an existing product or process;
- The process is technical in nature, meaning activities fundamentally rely on the principles of engineering, physical-biological, or computer sciences;
- Activities are intended to eliminate uncertainty regarding either the Company’s capability or method of achieving their goal, and lastly,
- Research and development are conducted through a process of experimentation.
What Qualified Research Expenses (QREs) are eligible for the R&D tax credit?
- Wages for qualified services
- Cost of supplies related to R&D projects
- Rental or lease costs of computers used in R&D projects
- Contract Research Expenses.
While identifying QREs is great, it is equally as important to meet the contemporaneous documentation requirements set forth by the IRS. A common source of dispute in IRS audits stems from taxpayers not being able to provide thorough documentation to support the credit reported on their tax return. To help mitigate these risks, GBQ’s R&D Credit team can perform a study to enhance the substantiation and corroboration necessary to protect and support the R&D credit claimed.
In these challenging times with limited options for ways of improving cash flow, the R&D credit could provide many businesses some financial peace and flexibility for R&D work they are already performing. If you have questions regarding your company’s eligibility for claiming an R&D tax credit, please contact one of GBQ’s R&D advisors, Jeff Waldeck or Leah Rogers.