The federal Research and Development Tax Credit is an incentive program providing taxpayers a dollar-for-dollar reduction of their tax liability; in effect, the Internal Revenue Service is helping to pay taxes for companies that qualify for the credit. While many companies take advantage of the R&D credit, most taxpayers don’t realize it can be claimed by businesses in many industries, most likely including yours.
The R&D credit was introduced and made part of the tax code in 1981 to help businesses conduct research and development activities in the U.S. at a cost that would be competitive with research being performed in foreign countries, especially Japan at the time.
Regulations regarding the credit have changed over the years; however, it has remained an important component of tax planning for many companies.
Recent changes to the R&D credit make it easier for a business’ research activities to qualify for the credit. Now, not only do we see manufacturers and technology and software companies claim the credit, but also pharmaceutical and chemical companies, engineering firms and bakeries, among others.
Tax-qualified research activities aren’t restricted only to new product development; they also include research to improve business processes and product efficiency.
Qualified expenses can include wages to supervise and support the research activity as well as the basic wages of the technical people performing the actual research. Third party contract research also qualifies, as do wages and supplies to produce a prototype.
If your company is either paying taxes as a C-corporation, or the owners are paying taxes via a flow through organization, you should determine if your business operations qualify for the R&D credit.
The amount of the credit can be as much as 10 percent of the qualified expenses, depending on your facts and circumstances and which of the two allowable methods to calculate the credit is elected. The credit can be claimed on a timely filed tax return (including extensions) or on an amended tax return.
The R&D credit technically expired on Dec. 31, 2013. Since its inception, the credit has historically never been a permanent component of the tax code.
However, it has been extended for 12-24 months each time it was set to expire, sometimes retroactively. The credit is once again in a similar position.
There is bipartisan support for extension in both chambers of Congress retroactively to Jan. 1, 2014, and tax extender legislation is pending. Last month, the House passed a bill that would extend the R&D credit permanently, which would give businesses considering R&D-qualified activities and expenditures greater certainty in the future.
The Senate Finance Committee has voted on tax extender legislation that would extend the R&D Credit, among other tax incentives, for two years through Dec. 31, 2015, while Congress considers a major overhaul to the tax code before President Barack Obama leaves office.
Most observers believe the Senate will vote to extend the R&D credit this summer and that a conference committee made up of members of the Republican-controlled House and Democratic-controlled Senate will hammer out final legislation, although final action may not happen until the fall.
In the meantime, businesses should continue to plan under the assumption that there will be an R&D credit for 2014.Â
Brett McGrath, Marcum LLP’s partner-in-charge of Connecticut tax & business services. John Vozzo is Marcum’s New England region research & development tax credit practice leader. Marcum is a national accounting and advisory firm with three Connecticut offices including in Hartford.
