The Research & Development Tax Credit: What is preventing you from claiming the credit

The Research & Development Tax Credit
What is preventing you from claiming the credit

The Research & Development Tax Credit came into law in the United States in 1981, and it was always a temporary provision of the IRS Code, that is until recently. 

The R&D tax credit is now permanent beginning with the 2016 tax year. 

This tax incentive is designed to encourage companies to invest in R&D, so what is holding you back?

If a business has activities that meet the four part test, then they can qualify for the R&D tax credit. 

The four part test is actually very simple and consists of:

  1. Permitted Purpose – Does the activity create new or improved functionality, performance, reliability, to a business component?  A business component can be a new or improved product process, technique, invention, software, or formula.
  2. Elimination of Uncertainly – Has information be discovered that would eliminate uncertainly of a business component?
  3. Process of Experimentation – Are one or more alternatives evaluated to achieve a desired result?
  4. Technological in Nature – Did the process of experimentation rely on principles of physical or biological science, engineering or computer science?

A business must use US labor to be able to claim the credit, but even if there are qualifying activities, a business may not be able to claim the credit due to utilization issues.  The R&D tax credit is just that, a tax credit, so if a business in not paying tax, then there is nothing for the credit to offset.  However, the R&D tax credit can be carry forward on the books for up to 20 years!

Due to many businesses experiencing utilization issues, things got much better for the credit beginning in 2016 through the PATH (Preventing Citizens from Tax Hikes) Act.  There were two significant enhancements to the R&D tax credit:          

  1. AMT (Alternative Minimum tax) for companies with less than $50M in gross receipts (prior three year average) can be reduced by the R&D tax credit.  This is significant for flow-thru entities.
  2. Start-up companies, who are usually in an NOL situation, with less than $5M of gross receipts for the year, and no gross receipts for more than the last 5 years, can now offset payroll taxes with the R&D tax credit.

Perhaps the fear of audit is holding you back from claiming the R&D tax credit?  In the “olden” days of the R&D tax credit, this was a big concern as the credit was an IRS Tier 1 Directive, but this is no longer the case.  In 2013 the Tier Directives were abolished. 

So, what is holding you back from claiming, or at least exploring the possibility of benefiting from this most powerful business incentive?  You should spend a few moments this tax season with your most trusted advisor, your CPA, to better determine if this is an avenue to be pursued.  Who knows, you may just end up reducing your tax bill!

Director, Engineered Tax Services

[email protected]

949-350-6369