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 Dick Peterson advises:
Innovation Can Pay ... In More Than
One Way
The federal Research and Development Tax Credit expired on December 31, 2007 after Congress adjourned for the year without extending it. But lawmakers are expected to take up the issue again in 2008 and renew the credit retroactively.
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History of the Credit
The Research Credit was enacted in 1981 to provide U.S. taxpayers with an incentive to increase spending for domestic research. The temporary credit expired and has been reinstated more than 10 times, so tax experts expect it to be extended in the future. |
The R&D credit is part of a package of tax breaks that are often called the "extenders" because Congress periodically extends them.
The question of when Congress will act is not known and the uncertainty can provide some planning and recordkeeping challenges for research-intensive companies.
Manufacturers often overlook significant tax savings from the R&D credit because they don't understand what activities qualify under the tax code.
Contrary to popular opinion, the credit is not just for scientific research done in a laboratory setting. It is also available to companies introducing new products, improving current products, and developing or enhancing their processes.
In other words, your company might be able to take advantage of this beneficial tax break simply by making its products better, faster or more cost effective.
If your firm is eligible, you can generally claim a 20 percent credit for related expenses above a base amount.
Alternatively, you might elect to use a three-tiered "incremental" credit approach based on reduced credit rates and fixed-base percentages.
For expenses incurred after January 1, 2007, there is also a new Alternative Simplified Credit (ASC) calculation available. The ASC applies a percentage to qualified expenses above a base amount. The base amount is determined by looking at qualified research and development activities for the prior three years.
Good news: In recent years, the IRS has relaxed some of the requirements for the R&D Credit. Even if your company didn't qualify in the past, it might be eligible for 2007 or future tax years. In addition, many states grant their own special tax benefits to companies engaged in research and development. And your company may be eligible for a refund if it engaged in qualified research in open tax years but never claimed a credit.
In brief, the Research Credit applies to four basic categories of expenses:
- Wages for in-house employees involved in research activities;
- The cost of supplies used in research;
- Payments for use of computer time in qualified research;
- A percentage of the cost of contracting with an outside party to conduct research on your behalf; or contracting with a qualified research consortium (such as a tax-exempt organization organized primarily to conduct scientific research).
Excluded Activities
Many activities qualify for the tax benefit, but as you may suspect, not all research is eligible. For example, you cannot get the credit for routine data collection, ordinary testing or inspection for quality control, or research related to the adaptation of an existing business component in response to a customer's requirement.
Qualified expenses must be undertaken to discover information that is technological in nature and intended to be useful in the development of a new or improved business component.
This article explains the general guidelines that apply to the Research Tax Credit. However, the process to collect benefits is complex. Companies must provide documentation showing that projects meet Congress' definition of research and development. So don't let the credit's uncertain status in Congress keep your company from planning ahead to take advantage of these federal and state tax breaks. Contact DMLO to discuss how to proceed.
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