What is the R&D tax credit and how does it work?
The research and development tax credit was enacted in 1981 to promote innovation and keep jobs in the U.S. A major regulation change in 2003 opened the door for small to medium size businesses to take this credit. The benefit can vary based on a company’s fact pattern, but as a rule of thumb, a company with $500,000 of qualified R&D costs can see a credit benefit of $25,000 to $35,000. Many states also offer an R&D credit which can double the benefit and can be refundable in certain states. Thus, the total credits may exceed $70,000.
The R&D credit is a permanent credit and computed annually, providing a nice annuity for the company taking advantage of the credit. The R&D tax credits can be determined for the current year as well as other open tax years. A 2016 law change now allows the credit to offset Alternative Minimum Tax for companies with less than $50M in revenue—making the R&D credit more beneficial than ever.
How do I qualify for the R&D tax credit?
Qualification for the R&D credit revolves around activities where the design is uncertain and there is an assessment of alternatives, whether it is the design, materials used, or how to apply technology in a new way to name a few. Activities that could potentially qualify for the credit include:
What is our process?
Our process is a three-step process. First, we have a general feasibility call to answer questions and better understand the R&D activities. This is a complimentary analysis during the pre-engagement phase. If agreed upon, we generally perform a phase 1 assessment which involves meeting with the company, discussing the credit rules and what activities qualify, and working through an initial calculation to estimate the federal and state R&D credit benefit for all open tax years. Phase 1 is typically performed at a nominal fee and involves an investment by the Eide Bailly team. After phase 1 is complete, we work with the company to determine the scope of phase 2 and for a fixed fee, we perfect the credit numbers through additional interviews and review of available information, and document the qualified activities through write-ups and the collection of contemporaneous documentation around the qualified activities.
What information is needed to claim the credit?
In general, the company will need two types of documentation. To compute the credit, the company will provide wages for individuals involved in the R&D, as well as a percentage of time that they spend doing R&D activities. Time tracking can be helpful, but is not a requirement. Estimates are acceptable for determining the amount of R&D time. The company will also provide total supply costs and third party contractor costs related to the R&D. The information will be gathered for the current year as well as prior years to compute the credit.
In phase 2, we collect contemporaneous documentation to support the qualified activities. The company will generally provide the following types of documents: project charters, power point presentations, design documents, emails discussing technical challenges, drawing iterations, or test reports to support their R&D activities. Our process utilizes the documents the company already generates and adds additional support through the interview process.
An agriculture equipment manufacturer with $24M in annual revenue was developing new and improved equipment to enhance its effectiveness and improve a farmer’s productivity. The manufacturer was also focused on improving their manufacturing processes. These activities resulted in federal and state credits totaling $112,000.
A label manufacturer with $40M in annual revenue was working with new materials and printing methods to develop customer packaging labels and converting solutions in the medical, industrial food and beverage, and household products industries. These activities resulted in federal and state credits totaling $75,000.
A manufacturer with $49M in annual revenue is focused on the design and engineering of new precision cutting products through the use of new raw materials and the development of new manufacturing processes. The qualified activities resulted in federal and state credits totaling $122,000.
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