Recently, we have seen an increase in the number of financial institutions taking advantage of the research and development (R&D) tax credit. Is your bank missing an opportunity?
What are R&D Tax Credits?
The R&D tax credit provides a dollar-for-dollar reduction in tax liability based on “qualified” activities undertaken by a company each tax year. The primary requirement for activities to qualify is that they be consistent with the purpose of the incentives: to promote design and development activities within the United States and the subsequent hiring and retention of technical staff to accomplish these tasks.
How Can I Determine What Qualifies?
This credit can be beneficial to companies across many industries. However, those in the financial services industry are often hesitant to utilize this credit because they likely do not understand that they may qualify. Many financial institutions invest significantly in software development and/or enhancement. This may include software to stay up to date with current trends and cybersecurity, development of online and mobile banking applications, or software targeted at automating various processes that once were manual. Financial institutions often develop or customize software to increase productivity/security, develop new functionality, edit current algorithms, or make other changes in an attempt to improve company operations.
The activities that many financial institutions perform on a day-to-day basis may qualify for the R&D Tax credit. These activities include, but are not limited to:
- Developing a new software application
- Enhancing an existing application
- Customizing existing software
- Testing new technology
- Integrating disparate software systems
Once it has been determined that a company is performing qualifying R&D tax credit activities, certain costs related to those activities must be identified and allocated to the qualifying R&D tax credit activities. The three areas of qualifying expenses include salaries and wages, supply costs and contract research expenses. The R&D tax credit is based upon a percentage of the qualifying expenses, therefore the larger the allocation of these expenses to qualifying R&D activities, the larger the amount of the credit.
Proposed regulations dealing directly with “internal use software” were released in 2015 that provide guidance for financial institutions undertaking software development efforts. The proposed rules are very favorable for taxpayers and loosen prior restrictions on claiming R&D credits for internal use software development.
Two other recent law changes that have increased potential utilization of the R&D tax credit include the option to elect the alternative simplified credit calculation and the availability to use the R&D tax credit to offset Alternative Minimum Tax (AMT) for eligible small businesses.
The Alternative Simplified Credit Calculation
Under the regular method for calculating the R&D tax credit, a base period amount needs to be determined to measure the current year’s qualifying expenses against. For companies in existence since 1984, this base period is from 1984-1988. However, obtaining information for that time period can be difficult, if not impossible. The Alternative Simplified Credit allows a company to compare the current year’s qualified R&D tax credit expenses against the prior three years, thus eliminating the need to gather and document information from 25 years ago.
Offset of AMT for Eligible Small Businesses
In the past, one limitation of the R&D tax credit was the fact that the credit could not be used to offset AMT; however, this recently changed. Starting in 2016, an eligible small business can use the R&D tax credit to offset AMT. An eligible small business is defined as a corporation whose stock is not publicly traded, a partnership or sole proprietor and whose average annual gross receipts for the three-year period preceding the tax year do not exceed $50 million.
R&D tax credit claims are extremely complex and are generated using the unique facts and circumstances of each company. In order to maximize available credits, it is recommended that companies seek the assistance of knowledgeable specialists who have technical, tax and legal expertise in this area. For more information on R&D Tax Incentives, or to determine if your activities may qualify, contact your local Eide Bailly service provider.