· Credit Amount
· Simplified Credit Calculation
· Failure to Take Advantage of the Credit
· Small Business Features
· Qualified Research Expenses
· Business Qualifications
An obscure tax credit—generally referred to
as the R&D (research and development) credit—was originally added to the
tax code in 1981 as a two-year incentive for businesses and has been extended
every year since, until it was recently made permanent.
The purpose of the credit is an inducement and reward
to get U.S. companies to increase their investment in research and
development for new, improved, or technologically advanced products or trade
processes, thus keeping the U.S. competitive with the rest of the world. Other
applications of the credit may include improvement upon the functionality,
reliability, performance, or quality of existing products or trade processes.
The credit (IRC Sec
41) is generally 20% of the increase in research activities over a base amount
and includes some very complicated calculations related to payments made to
certain outside organizations and for energy research.
The base amount is a fixed percentage of a taxpayer’s average annual
gross receipts from a U.S. trade or business, net of returns, and allowances
for the 4 tax years before the credit year. It can’t be less than 50% of the
current year’s qualified research expenses.
is also a simplified credit calculation, which may be more suitable for a
smaller business, that is equal to 14% (instead of 20%) of the excess of the
qualified research expenses for the tax year over 50% of the average qualified
research expenses for the three tax years preceding the tax year for which the
credit is determined.
Most of the
complications involve larger businesses, while smaller businesses may fail to take
advantage of the credit, not realizing those complications probably do not
apply to them. Thus, many medium- to small-size businesses fail to claim the
credit. The good news is that if your company qualifies for the credit and hasn’t
utilized it, it can be claimed on an amended tax return for a prior year that
is within the statute of limitations.
The credit also includes two features that are favorable to small businesses ($50 million or less in gross receipts).
· They may claim the credit against the alternative minimum tax (AMT) liability, and
· The credit can be used by even smaller businesses ($5 million or less in gross receipts) against the employer’s part of the Social Security portion of the employer’s payroll tax (the FICA liability).
To qualify for the
credit, the research and development must be conducted on U.S. soil (including
Puerto Rico and U.S. possessions) and generally includes qualified research
expenses, defined by the tax code as:
Qualified wages paid to or incurred by
Supplies used in research and
development other than:
Land and improvements to land and
Property that is subject to depreciation.
Contract research expenses paid to a
person other than an employee for qualified research. However, only 65% of
these expenses qualify.
Consortium expenses (research
expenses paid to certain nonprofits engaged in scientific research) limited to
75% of the expense.
Amounts paid to eligible small
businesses, universities, and federal laboratories.
Qualified energy research at 100% of
Are intended to resolve technological uncertainty related to the
capability or methodology for developing or improving the business component or
the appropriate design of the business component.
Rely on a hard science, such as engineering, computer,
biological, or physical science.
Are related to the development of a new or improved business
component, defined as new or improved products, processes, internal use
computer software, techniques, formulas, or inventions to be sold or used in
the taxpayer’s trade or business, and
Entirely constitute a process of experimentation involving
testing and evaluation of alternatives to eliminate technological uncertainty.
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