American businesses are continuously working to develop new products, create new processes, improve quality and increase efficiency. While many business owners consider these efforts a normal part of doing business, the federal government and the state of California believe that this process of innovation is critical to the future of the economy. To provide incentive and reward companies that choose to invest in research and development (R&D), lucrative state and federal tax credits were created.
Smart Business spoke with Gary Price, a tax partner at Sensiba San Filippo LLP, to learn more about R&D tax credits and how qualifying businesses can benefit.
What do business owners need to know about R&D tax credits?
Business owners should first be aware that R&D credits can be extremely valuable. Next, businesses should know that the definitions of qualifying research are in some ways more expansive than many know. Many businesses that qualify for R&D credits don’t know that they qualify and miss out on valuable tax savings.
What activities qualify for R&D credits?
R&D tax credits reward very specific activities defined by the federal tax code. In order to qualify, research must meet a four-part test. First, the research must be performed to discover information about improving or developing a business product or process. Next, the information that the research seeks to discover must be technological in nature. The research also must include a process of experimentation. Finally, the research must relate to a new or improved function, performance, reliability or quality.
What expenses can be included when calculating R&D credits?
Only specific types of expenses related to qualified research can be included in credit calculations. These include wages, supplies and contract expenses paid to a third party for qualified research.
How are R&D credits calculated?
Credits can be calculated by comparing current year qualifying expenses to research expenses in previous years. If a business didn’t have many research activities in prior years, the credit will be approximately 6.5 percent of the current year’s research expenses. There is also an alternative method for calculating the credit if the business doesn’t generate any credit under the regular method. The California credit uses a similar calculation and can actually produce even larger credits.
With the federal R&D credit currently expired, what should businesses expect in the future?
While the federal credit has expired, most expect Congress to once again renew the credit in time for 2015 filings. Congress has a long history of extending the R&D tax credit, but the process of allowing the credit to expire before renewing it just in time for tax filings can make planning a challenge.
Many prominent businesses and lawmakers are calling for a permanent extension of the R&D credit. With uncertainty regarding the credit’s future, businesses could look to move their research to friendlier countries. Making the credit permanent would help to prevent a brain drain where research-related jobs could be transferred to other countries.
How can businesses determine whether they qualify for R&D credits?
The best way to determine whether your business may qualify for credits is to speak to a CPA who has specific experience regarding the R&D credit. To determine eligibility, you will need to not only know the definitions, but also how they apply to your specific activities. Your financials will also play a role in your ability to utilize identified credits. Working with a qualified adviser can help you understand the potential benefit that R&D credits could provide you as well as the process that will be required to document, calculate and file for credits.
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