Business research incentives come in so many forms across various jurisdictions that they apply to more companies than you think. Although the bulk are used in manufacturing, consumer products, biotech or pharmaceuticals, they are available to anyone developing or creating something, whether a product, process, technique, software, new technology or a new application of an existing technology.
“A lot of people are aware that these incentives exist, but often they don’t make the leap that it applies to their company,” says Trisha Squires, director of tax at SS&G’s Chicago River North office.
A company could make nuts and bolts for 100 years using similar equipment, but if it has improved its cost margins by changing development, it could still qualify for certain research incentives, she says.
Smart Business spoke with Squires about how to ensure your company’s research and development (R&D) qualifies for available incentives.
What research incentives are available?
It’s typically a tax savings — either a credit or a deduction. Sometimes, it’s a refundable credit, so you don’t have to pay taxes in that jurisdiction. Certain global or state incentives are super deductions where, for example, you get 150 percent of the cost. You also might get tax abatements.
The federal research credit is essentially 6.5 cents on the dollar, depending on the method of calculation. You are rewarded for increasing the amount spent on R&D at a greater rate than you are for increasing your gross receipts. The credit expires and is reinstated so often that companies don’t pay attention.
The IRS spends a lot of time fighting these credits with an array of qualifications and substantiation arguments. Evidencing what you’re doing with R&D is extremely important. You must spell out the new functionality or improvements. This typically is not documented for any other reason. You have to look at the credit, and then align your facts and documentation to match the requirements.
How do state and global credits work?
State and local incentives vary. They can be as easy as in South Carolina, which is 5 percent of qualified research expenses, or as complex as California, which has its own formula. Ohio’s tax credit for research and experimentation expenses was extended through 2013. The majority of businesses figure out their federal credit, then state.
Globally, research incentives are less reactive. Canada has similar qualifications to the U.S., but it qualifies projects and dollars prior to the filing of returns. Europe is very friendly to R&D. In the Asia-Pacific region, companies often have tax abatements and incentives may not apply.
Has anything recently changed in this arena?
In 2005, the IRS came out with its Tier 1 Program as an attempt to bring consistency in application to normally contentious areas, such as the R&D credit and transfer pricing. However, the initiative required more documentation and accounting on a project-by-project basis. Creating a nexus between the activity and the dollar spent on that activity was very onerous.
The IRS got rid of the program at the end of 2012, but how it thinks about the credit and what’s required hasn’t changed.
What’s your advice for business owners?
Most companies and their people are very comfortable gathering the dollars that qualify. It’s gathering the qualitative documentation — the text that describes why they qualify for the credit — where companies fall short. These are details about who was working on the project, what their role was and what kinds of experimentation were involved. The tax department, engineering group or both have to put this documentation together, and many are not getting enough substantiation.
You may need outside help with this, especially if it’s new to you. If your tax year is still open, you can go back three years to claim prior credits. When an adviser gathers data for one year versus four, it’s not that significantly different, so you could be looking at some worthwhile savings.
The credits and other R&D incentives are vast and can provide substantial savings that affect your bottom line. It’s also likely that your competitors are taking them.
Trisha Squires is director of Tax at the Chicago office of SS&G. Reach her at (312) 863-2300 or [email protected].
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