The Research & Development Tax Credit is an engineering based program that focuses on a company’s operations and processes in order to determine their qualification for incentives.
This benefit provides an avenue to receive tax money back from prior years while also reducing current taxable income on a dollar-for-dollar basis.
The R&D Tax Credit was originally enacted as a Federal Tax Program in 1981 and was designed to encourage American investment in innovation and creativity. In 2004, tax regulation changes significantly expanded the credit opportunity.
Most organizations don’t have an R&D department and probably don’t consider what they are doing is research and development. They are making these improvements and changes because they must stay competitive and yet, as the government sees it, “R&D” is exactly what they are doing.
In 2001, the IRS changed the definition of R&D and the changes were so broad it virtually encompasses all manufacturing or technology organization in some way.
One misconception is companies believe they need to be a manufacturer to qualify. This couldn’t be further from the truth. In fact, if you perform any engineering activities, design, CAD, quality assurance, fabrication, process improvement, prototyping, modeling, develop patents or software development you would qualify for the R&D tax credit.
The benefits of having an R&D Tax Credit Study performed include the following:
• Dollar for dollar credit against taxes owed or previously paid
• Tax refund on prior years with interest
• Carry forward credit for future profitable years up to 20 years
• Immediate increase in company cash flow
• Credit average is more than $25,000 per $1,000,000 in total company payroll
The IRS allows companies to go back three open tax years to take advantage of the credits they may have missed. Just 120 days after submitting the amended returns, you can get cash in your pocket. Additionally, you can take credits for current and future years if you continue to perform activities that qualify for this credit.
In order to best qualify in accordance with the IRS standards, you should not simply complete forms. The R&D study should be an exhaustive effort of interviews, project by project documentation, evaluation, and detailed analysis, performed by a team with an expertise in the R&D study – most notably IP/Tax attorney’s and engineers. This ensures credibility and validity of the study. The result should typically be a detailed engineering report.
The magnitude of the R&D Tax Credit’s economic effects are debated by many economists but a majority of them agree the credit does increase R&D spending in the United States. While measuring the actual effect of the credit is difficult, a 2005 study by Ernst & Young measured the amount of dollars returned to companies in the form of the R&D Tax Credit. Some 17,700 corporations claimed $6.6 billion in R&D Tax Credits on their tax returns in 2005. About 11,300 C corporations and 6,400 S corporations claimed the credit.
Of corporations claiming the R&D Tax Credit in 2005, 29 percent had $1 million in assets or less, 25 percent had assets of $1 to $5 million, 25 percent had assets of $5 to $25 million, and 21 percent ahd assets of more than $25 million.
Some 14,953 corporations with less than $50 million in total assets claimed more than $891 million in Federal Research and Experimentation Tax Credits. More than 70 percent of these corporations had a Standard Industrial Classification in some type of Manufacturing, the remaining include Services, Information, and Agriculture.
• Jeff Ernst is managing director of Ernst Consulting Group. He can be reached at firstname.lastname@example.org or 877-221-8811.