As I often mention to my clients and business colleagues, I’m simply amazed at the number of manufacturing and technology companies that have yet to take advantage of the federal R&D tax credit as well as similar tax breaks offered by about 40 states. The R&D tax credit, which is regularly used by America’s largest companies, is vastly under-utilized by the nation’s small and mid-sized producers and innovation businesses. The reasons for not utilizing the research credit vary widely, though the principle causes relate to confusion about what expenses and activities qualify for the credit and the complexities associated with computing the credit.
The R&D Tax Credit, officially named the Credit for Increasing Research Activities, is a general business credit that was implemented to assist businesses that incur expenses relating to the development of new products and manufacturing processes. The credit, which was originally introduced by Congress in 1981, is intended to provide tax relief to companies that develop new or improved products and fabrication processes. In addition to the federal tax credit, many states provide their own R&D tax credit.
The goal of the R&D tax credit is to retain high tech and manufacturing jobs in the U.S. Businesses that are eligible to utilize the R&D tax credit include all sectors of manufacturing as well as architectural and engineering firms, software developers, bio-technology and other life-science companies, food and beverage producers, and others.
To qualify for the R&D Tax Credit, a company must demonstrate it conducted one or more of the following activities:
- Developed products or processes where the specific know-how is not in the public domain, or
- Developed a new or improved product that advanced the state of the art as well as required one or more design iterations or experimental trials to achieve, or
- Developed or incorporated a new technology in order to catch up to a competitor, or
- Attempted to develop a product or process improvement that was eventually abandoned.
The company must also have incurred costs in any of the following:
- Development of new products
- Software development
- Prototype fabrication
- Production tooling
- Materials consumed during testing
- Sample parts to refine a process
- Consultants or subcontractors
- Testing labs
How much is the R&D Tax Credit worth?
The federal R&D tax credit can amount to as much as 14% of the costs incurred developing new products or fabrication processes. The credit, which can be computed using either of two available methods, is dependent on a variety of factors including the in-house wages incurred carrying out the qualifying activities as well as the costs of materials and contracted services relating to the development work. Get a rough approximation of the credit your company might be entitled by using the Research Tax Credit Estimator.
What do I need to do to claim R&D tax credits?
Despite the fact that the R&D tax credit has been available since 1981, the IRS estimates that only 10% of eligible companies recognize that they qualify for the credit and receive it. If you think your business qualifies for R&D tax credits, speak to your CPA about the credit or ask them to refer you to a specialist if they are not familiar with the tax guidelines.
Is your company eligible for a tax credit regarding your innovative product or process development efforts?
Steve Powers is a founder of First Beacon Business Advisors and also president of Intrepid Advisors, a specialized business advisory firm offering expertise and consulting services relating to federal and state Research & Development Tax Credits.