Most people hear the phrase “Research and Development” or “R&D” and think “That doesn’t apply to me”. They think the term implies only to the use of scientists in a lab. In reality, the definition of Research and Development as it pertains to the income tax credit is quite broad.
“Qualified Research” is defined in the Internal Revenue Code as research that:
1. Is considered a deductible R&D expense under the Internal Revenue Code Section 174,
2. Is purposefully done to discover new information that is technological in nature,
3. Where the intended application is that it will be useful in developing a new or improved business component, and
4. A majority of the activities involved in the experimentation process are for a new or improved function, performance, or reliability or quality.
To be clear, some activities like the ones listed below are not considered “qualified research” for purposes of claiming the tax credit.
- Research conducted after the beginning of commercial production.
- Research related to adapt a product to a particular customer’s need.
- Any efficiency survey or activity relating to management functions or techniques, marketing research/testing.
- Routine testing or data collection for quality control.
- Any research conducted outside of the United States.
- Any research in the social sciences, arts, or humanities.
But many businesses engage in R&D activities and don’t even realize it. To them they are just trying to remain competitive in their industry or reduce costs. Manufacturers in particular are always looking for ways to improve their processes.
Research can come from a well-planned approach, or sometimes from trial and error. The good news is that to qualify for the credit, the project does not need to be some large well thought out plan. To qualify, the activity does not need to be successful, but there must be inherent risk in its undertaking.
The tax benefits associated with claiming a R&D tax credit can be quite lucrative. The credit is based on the amount of qualifying wages. So you want to review projects where your personnel are your highest expenditure. These people may be employees or subcontractors, and are often engineers or industry experts.
It’s important to have proper documentation to support any R&D tax credit claimed. This is often referred to as a “study”, and can be done internally or externally. Regardless, you should seek out expert guidance on what projects qualify.
If after reading this article you think your company might be engaging in R&D activities, I recommend contacting an expert to help you take a closer look into your business activities. It’s important to have a CPA review your particular tax situation to ensure that the time and/or money spent conducting a study on your activities is worthwhile. If you have questions pertaining to the R&D Credit and how you may benefit, MKS&H would be happy to help.
About MKS&H: McLean, Koehler, Sparks & Hammond (MKS&H) is a professional service firm with offices in Hunt Valley and Frederick. MKS&H helps owners and organizational leaders become more successful by advising them regarding their financial, technology and human capital management needs.