Getting the Most Out of the Research and Development Tax Credit

Estimated Time to Read: 3 minutes

The Federal R&D tax credits were introduced by the US government to encourage invention and boost investment in the country. According to 2014 R&D credits report, over 100,000 taxpayers claimed more than $12 billion for research work performed by their companies on daily basis.

The big surprise is a significant portion of the credit dollars were claimed by Fortune 500 companies and many SME’s did not apply for the R&D credit though their research work was eligible. Here are some facts and guidelines that will help you get most out of the research and development tax credit.

Know What Qualifies

The research conducted in your company should meet the criteria specified in R&D credit QREs (Qualified Research Expense) qualifying guidelines for receiving credit. The research should be technical in nature and integrate into one of the sciences (Physics, Chemistry, and Biology). Research activities that involve the use of computational design tools that helped you create a new functionality or improve any existing functionality also qualify for receiving R&D tax credits.

Similarly, process improvements that focus on enhancing characteristics like reliability, durability, or designing the product for better energy efficiency are also considered credit worthy. Experimentation is also included in qualified research activities and if your company has experimented to consider an alternative design process or different design to reduce material costs then your activities fall under QRE’s.

The R&D credit guidelines allow you to claim tax credits against modest research or new takes that might be very common in nature for your company. For example, activities like improving the natural light in the hospital for better healing can also give you R&D tax credits.

What Does Not Qualify?

The R&D tax credits cannot be claimed for research activities that were performed after the product is developed successfully or design produced commercially. Activities like duplication or adaptation of existing business component, studies, surveys conducted to improve organization’s internal operations are not QRE’s.

How Is the R&D Credit Value Calculated?

There are three types of research credits for companies. Each type of research credit is calculated differently.

Traditional Credit

The Traditional Credit is given to companies that were incorporated prior to January 1st, 1984, and have more than three tax years with research expenditures from January 1st, 1984, to January 1st, 1988. The fixed-base percentage is calculated by dividing the taxpayer’s aggregate QRE by the aggregate gross receipts for taxable years starting from 1983 but before January 1st, 1989. Following is an example that shows the traditional credit calculation.

Company A has total $270 QRE and the gross receipts for the 1984-1988 base period is $5,750. Hence the

· Fixed base percentage will be -270/5750 X100 = 4.7%

· Company’s gross receipts over four prior years is 1,425

· Base amount will be 4.7% of 1,425 = $67

· Company ‘s QRE for 2015 is $100

· The Creditable amount for 2015 is 100 -67 = $33

· Company A’s R&D credit amount for 2015 is 20% of 33 = $6.6

Alternative Simple Credit

Companies that cannot generate fixed base percentages or substantiate qualified research expenditures for the traditional or startup methods can calculate the credit they can receive by Alternative Simple Credit. This calculation can provide credit up to 12% of QRE’s that exceed 50% of the average QRE’s for three preceding taxable years. Here is an example which shows the calculation of Alternative Simple Credit.

· Company B’s average QREs for three prior years was $92

· The base amount will be 50% of $92 = $46

· Company’s current year QRE is $100

· The Alternative Simple Credit Company B can claim 12% of $54( 100-46)= $6.48

Taking Action

R&D credits experts say claiming the credit is quite simple. All you need to do is show the qualifying work. Given you have strong documentation practices; it would be easy for you to back up the R&D expenses claim.

As you can see the eligibility rules of R&D tax credits are clear and explanatory. If you are still having any doubts, you can seek help of R&D tax consultants to apply for R&D credits.