When most people think about the type of businesses that would qualify for the Research and Development (R&D) tax credit, they automatically think of large laboratories, software, chemical, and biotech companies. However, contrary to popular belief, many small to medium sized companies participate in activities that may qualify them for the R&D tax credit.
The following article includes additional information on the R&D tax credit, including details on the amended regulations that allow alternative simplified research election on amended returns.
What is the R&D tax credit?
The R&D tax credit is a federal credit that was originally implemented under the Economic Recovery Tax Act of 1981 as a way to stimulate research, development, and innovation by US companies. Since that time, the credit has undergone several changes in order to boost utilization by small to mid-size businesses and to ensure appropriate carry over provisions for all businesses. The credit is among the biggest and most significant tax incentives available to taxpayers.
Who can claim the research expense credit?
A taxpayer who pays or incurs qualified research expenses in carrying on a trade or business.
What qualifies as “research and development?”
Research activities related to the development or improvement of business component are treated as qualified research if they meet all of the following requirements:
- Research is being performed in order to discover information that is technological in nature, and
- The application of which is intended to be useful in the development of a new or improved business component, and
- Substantially all of the activities of which constitute elements of a process of experimentation for a qualified purpose, but that purpose may not relate to style, taste, cosmetic or seasonal design factors.
The above definition of research and development activities is relatively broad and may include activities such as developing prototypes or models, developing or applying for patents, certification testing, environmental testing, and building or improving manufacturing facilities. Qualifying expenses that are eligible for the R&D credit are limited to wages for performing or directly supporting qualified research, the cost of supplies, and contract research expense.
How is the R&D tax credit calculated?
Currently, there are two methods for calculating the credit:
- Regular Credit. 20% of the excess (if any) of the qualified research expenses for the tax year over a base amount.
- Alternative Simplified Credit (ASC). 14% of qualified research expenses over 50% of average annual research expenditures over the past three years.
Electing the Alternative Simplified Credit on Amended Returns
Recently, the IRS issued temporary regulations to allow taxpayers that did not claim an R&D credit on a previous timely filed return (including extensions) to elect the ASC on an amended return for that year. These changes were made in response to requests that the burden of substantiating expenditures and costs for the base period under the regular credit can be costly, time-consuming and difficult.
The new regulations apply to elections with respect to tax years ending or after June 3, 2014, and expire on June 2, 2017. A taxpayer may rely on the new regulations if the taxpayer makes the election before the period of limitations for assessment of tax has expired for that year.
How Does the R&D Credit Work?
In order to apply for the R&D credit, businesses must determine the amount of eligible expenses and prepare and retain documentation in order to substantiate those expenses. The non-refundable credit reduces tax and will carry forward 20 years in cases where the credit is not used in the current year. For S-Corporations and Partnerships, the credit would flow through to the members’ personal tax returns.
There is also a Nebraska R&D credit in the amount of 15% of the federal credit. The Nebraska credit is refundable to the company.
If you think your business may be eligible for the R&D tax credit, please give our office a call at 402.423.4343. Our team of qualified tax professionals is here to help.
By Jimmy D. Schulz, CPA, CVA, Partner