By CHRIS NOBLE //
Research and development activities are critical to driving innovation and economic growth. Recognizing both their value and their associated expenses, the R&D tax credit was first established some 40 years ago.
For technology companies with active R&D programs, it’s important to understand the qualifying criteria, eligible expenses and what’s required to claim a federal R&D tax credit.
The R&D tax credit was introduced by the U.S. Congress in 1981. It was initially a temporary measure, but in 2015, long after it was apparent that private-sector R&D investments were growing, creating jobs and representing a larger share of the nation’s gross domestic product, the tax credit was made permanent.
The Protecting Americans From Tax Hikes Act, which made the R&D tax credit permanent, also made it available for startups.
The R&D tax credit is available to any taxpaying business, in fact, regardless of size or industry. The business must be working to develop new, improved or innovative products, software or business/trade processes. There is a wide range of R&D activities that could qualify.
The Discovery Rule, which required that the R&D activity represent something new, was changed in 2003 to state the R&D activity simply had to be new to the taxpaying business. Some examples of qualifying R&D activities include developing or improving algorithms for enhancing computer processes or software architectures, upgrading order-management and e-commerce systems and advancing artificial-intelligence or speech-recognition solutions, among others.
Chris Noble: Where credit is due.
The IRS has developed a four-part test to qualify for the R&D tax credit. The activities must relate to the development of a new or improved business component, defined as a product, process, software, formula or invention to be sold or used in a taxpayer’s business; they must also be intended to resolve a technological uncertainty, which may be related to achieving project goals, designs or techniques required for developing the business component.
The activities must also rely on a hard science – such as engineering, computer science, biology chemistry or physics – and constitute a process of experimentation involving testing and evaluating alternatives.
Businesses meeting these requirements also need to know what expenses are eligible for the R&D tax credit. These fall into different categories and include wages paid to employees directly performing “qualified research activities,” along with wages related to supporting or supervising those individuals, and supplies consumed in the process of experimentation, or used to build and test prototypes.
Certain rental or lease payments to cloud service providers for development-related server hosting costs can also qualify, along with third-party contractor expenses related to research activities and basic research payments made to qualified educational institutions and scientific research organizations.
Gaining the R&D tax credit also requires businesses to substantiate the expense-related items. This can be done with various documents including payroll records, general ledger expense entries and project-management records.
Qualifying technology companies can gain significant benefits from the R&D tax credit. It can reduce a company’s tax liability and lower overall effective tax rates. Depending on a company’s stage and size, it can also be used against payroll taxes or income tax liability.
Additionally, the tax credit generates cash flow that can help drive ongoing R&D activities.
Qualifying for this valuable tax credit requires the expertise of a certified public accountant with experience determining the proper calculation and claiming of the credit. But done properly, the R&D tax credit can provide a business with a competitive edge – and ultimately lead to growth.
Chris Noble, CPA, CGMA, is a partner at New York City-based Anchin, Block & Anchin and head of the firm’s Technology Group.
