The Research and Development Tax Credit was implemented in 1981 and in 2015 it became a permanent part of the US tax code when the Protecting Americans from Tax Hikes (PATH) Act was signed into law. Greg Knarr, writing in Industry Week, calls it “our government’s primary incentive to reward businesses for driving industry progress and for keeping technical jobs on U.S. shores.”
Surprisingly, “even though most businesses that implement automation systems are eligible for the credit, only about 5% actually take the time to go through the process of claiming it” says Knarr. Your tax preparer can advise you on your potential eligibility for R&D and other tax credits – it could be well worth your time to investigate!
According to Tom Taulli in Forbes, examples of covered projects include “software development (whether for sale or for internal purposes), design tools, dies, molds, patents, certification testing, environmental testing and automated manufacturing processes.” However, the credit is not applicable for surveys, management studies, marketing research or other social science initiatives.
Qualifying projects are eligible for a tax credit equal to a portion of your relevant expenses. These Qualified Research Expenses (QREs) are defined in section 41 of the Internal Revenue Code. QREs must result from work performed in the US and can include:
- salaries of those doing the R&D work (including direct supervision and direct support staff)
- supplies and equipment (excluding land and land improvements)
- contracted research (65% of actual costs)
Does my project qualify?
To be eligible for the credit, your project must pass a four-part test:
- Elimination of Uncertainty: you must show that you’ve removed uncertainty as to if or how you can accomplish your development or improve your process, or that you have developed an ultimate design for it
- Process of Experimentation: you must show that you’ve evaluated more than one solution through trial and error, modeling, simulation or another process
- Discovering Technical Information: the innovation or process must involve the hard sciences such as engineering, physics, chemistry, biology or computer science
- Business Component: your innovation must improve a product or process or result in an increase in performance, reliability or quality
As with all business matters, recordkeeping is critical. Taulli suggests keeping project documentation “such as emails, billings, payroll records, specs, project timelines, diagrams, drawings, flowcharts, meeting schedules and so on.” You’re also able to carry forward expenses for 20 years or amend returns as far as three years back for a refund.
Many states also have R&D tax credit programs. Note that provisions vary by state and may differ from those of the federal government. Many states require that the relevant work be performed within that state. Check with your state department of taxation to learn more.
What about small companies and startups?
Don’t assume the credit is only for large, established companies. The 2015 PATH Act included two new provisions specifically for small businesses and start-ups, according to CPA Journal:
- Eligible Small Businesses (ESBs) may apply the credit against their Alternative Minimum Tax (AMT) for tax years after December 31, 2015. An ESB is defined as “a corporation that is not publicly traded, a partnership, or a sole proprietorship with average annual gross receipts not exceeding $50 million for the three taxable years preceding the current taxable year.”
- “Startup businesses with no federal tax liability and gross receipts of less than $5 million [may] take the R&D tax credit against their payroll taxes for tax years beginning after December 31, 2015, essentially making it a refundable credit capped at $250,000 for up to five years.”
In today’s business world, innovation is the key to success. If you’re looking to improve or automate your manufacturing processes, remember Force Design. We’re your source for controls and mechanical engineering, automation strategies, and of course, ongoing support. Contact us today to learn more!
How a little-known tax credit can pay off big in automation costs – Industry Week
US Research and Development Tax Credit – CPA Journal
Secrets for claiming the R&D tax credit – Forbes
Credit for increasing research activities - 26 U.S. Code § 41
State R&D Tax Credits Benefits and Eligibility Map – Intrepid Advisors
State departments of taxation links – AICPA