R&D TAX CREDIT

R&D tax credits are incentives provided by our government to encourage U.S. companies to maintain their competitive advantages through continued innovation and improvements. The incentives are targeted at the development of new or improved products and processes of a fundamentally technological nature. At Tri-Merit, we support CPAs with the engineering, manufacturing, and product development experience needed to provide detailed R&D tax credit studies. We utilize our proprietary methodology which is based on a systematic evaluation of the credit regulations, and client specific facts and circumstances to produce highly successful and sustainable results. With the passage of the PATH Act, R&D tax credits are now available to more businesses than ever before, including start-up enterprises.

Eligibility

At the highest level, research and development efforts must meet four basic criteria to be eligible for the federal tax credit.

  • The project must be intended to be useful in the development of a new or improved business component for the taxpayer, such as a product, process, technique, formula, invention, or software.
  • The project must be undertaken for the purpose of discovering information that is technical in nature. Thus, the activity must rely on the principles of physical sciences, such as engineering, biology, or computer science.
  • The project must be intended to eliminate uncertainty related to the development or improvement of a business component. Uncertainty can include the capability, development method, or optimal design of the business component.
  • The project must evaluate one or more alternative solutions through the development, refinement, and testing of different options. Further, technical risk must be present, which means that there is a chance the project will not be successful.

There are no hard or fast rules about which companies or industries qualify; potentially anyone with qualifying activities can take advantage of the credit.

Companies are frequently misled by the R&D name and mistakenly believe their business is not involved in research or development. Most businesses are routinely involved in common activities to develop or refine their products and processes to stay competitive, and thus potentially qualify.

Regardless of the nature of a business, as long as qualified research and development activities are being performed, there is an opportunity to pursue R&D tax credits.

Under changes introduced in the PATH Act, more companies may now benefit from R&D tax credits. An Eligible Small Business (ESB) with $50M or less in average gross receipts in the past three years may now offset the Alternative Minimum Tax (AMT) making the R&D credit beneficial to many manufacturers who were previously limited in the current use of the credit by AMT. A Qualified Small Business (QSB) with less than $5M in gross receipts may offset a portion of their payroll taxes, benefitting many new businesses who were previously not able to receive a current benefit.

Many industries include the types of functions that may qualify for an R&D tax credit claim. To learn about industry specific products and process that may qualify your company for a tax credit, select an industry from the list below.

ARCHITECTURE
Qualified activities may include:
  • Innovative or unique designs for various structures
  • Experimenting with the use of new or alternative materials
  • Computer-aided design (CAD) and computer-aided engineering (CAE) activities
  • The design and development of innovative or unique new LEED, energy-efficient, or "green" alternatives
AEROSPACE
Qualified activities may include:
  • Research on new materials to be used in aircraft production and processes for design and construction
  • Engineering evaluations and design modeling
  • Contractor salaries for research, design, testing, or modeling
  • Fuel efficiency studies
  • Equipment component and design studies, either in-house or performed by contractors
  • Design and development of simulation software
CNC MACHINING
Qualified activities may include:
  • The design and development of new or improved tools, fixtures, and jigs
  • CNC Programming and program optimization
  • The development of new or improved set-ups
  • Developing new or improved part loading or extracting systems
  • Computer-aided design (CAD) and computer-aided engineering (CAE) activities including modeling and simulation
  • Prototype part production runs to test and validate new or improved products or processes
  • Quality assurance activities related to new or improved parts or manufacturing processes including CMM programming and setup.
  • Process improvement projects to improve part quality such as surface finish or other GD&T specifications.
  • Experimenting with the use of new materials to be used in tools or parts.
  • The design and development of new equipment or machinery, or improvements to existing equipment or machinery that result in increased uptime, improved quality, and reduced cycle-times
CRAFT BREWING
Qualified activities may include:
  • Development of new or improved processes, or experimentation with the effect of process changes such as fermentation time and temperature.
  • Development of new or improved equipment or automation, either in the fermentation process or in the bottling / canning process, or in the water filtration process.
  • Development of new internal-use software tailored to the brewing industry.
  • Research to reduce waste, reduce water consumption, or reduce energy consumption (green initiatives).
  • Developing methods for the utilization of spent grain including conversion to energy.
  • Hop breeding.
  • Experimentation with prototype packaging alternatives, e.g., various keg sizes, cans vs. bottles, 22oz bottles, growlers, and similar issues.
  • Experimentation with new formulations, additives, and ingredients to create new or improved products.
  • Experimentation to achieve specific product parameters including:
    - Flavor or taste profiles
    - Alcohol content
    - Color or appearance
    - Level of carbonation
  • Creating prototype sample test batches.
  • Development of pilot brewing systems and labs for developing new products
DIE CASTING
Qualified activities may include:
  • The design and development of new or improved dies
  • The development of new or improved gating and venting designs
  • Developing new or improved part ejection systems
  • Computer-aided design (CAD) and computer-aided engineering (CAE) activities including modeling and simulation
  • Construction of prototype dies
  • Prototype part production runs to test and validate new or improved products or processes
  • Quality assurance activities related to new or improved parts or manufacturing processes
  • Process improvement projects to improve part quality such as surface finishes, etc.
  • The design and development of new equipment or machinery, or improvements to existing equipment or machinery that result in increased uptime, improved quality, and reduced cycle-times
ENERGY
Qualified activities may include:
  • Field studies conducted on potential sources
  • Studies conducted related to exploration or drilling, or improvements to processes in those areas
  • Efficiency modeling conducted to develop or evaluate new processes
  • Lab testing of materials or sources
  • Contract labor associated with project management, evaluations or development
  • Research studies associated with new recovery techniques
ENGINEERING SERVICES
Qualified activities may include:
  • The design and development of innovative new or improved infrastructure projects such as bridge structures, and light-rail systems
  • The design and development of innovative or unique waste-water treatment facilities, pump stations, or other water supply facilities
  • Drainage design, structural design, and other ancillary engineering design and development efforts
  • GIS and other software development activities
  • The design and development of SCADA and other control or management systems
  • Modeling and simulation of new or improved designs for testing and evaluation purposes
  • Computer-aided design (CAD) and computer-aided engineering (CAE) activities
FOOD SCIENCES
Qualified activities may include:
  • New product development, and product improvements or enhancements.
  • Experimenting with different ingredients or formulations to reduce costs and improve preservation.
  • Experimenting with different parameters or processes to cook or prepare food to achieve certain advantages.
  • Developing new or improved packaging.
  • Developing methods to extend product shelf-life.
  • Developing improvements to manufacturing processes to be more efficient, increase equipment uptime, and reduce cycle-times.
  • Development of automation to replace manual processes.
  • Developing new manufacturing processes or equipment, or improving manufacturing processes or equipment.
MANUFACTURING
Qualified activities may include:
  • Retrofitting existing lines or improving existing techniques
  • Design planning for new processes directly related to manufacturing.
  • Equipment related to development and testing of processes or techniques
  • Materials research and testing
  • Salaries for skilled workers and for contract services
  • Component evaluation process
PHARMACEUTICALS
Qualified activities may include:
  • Research costs are the first area to consider
  • Lab testing of both development processes and compounds can be evaluated
  • Data modeling software and labor costs
  • Materials development
PLASTICS & INJECTION MOLDING
Qualified activities may include:
  • The design and development of new or improved molds
  • The development of new or improved gating and venting designs
  • Developing new or improved part ejection systems
  • Computer-aided design (CAD) and computer-aided engineering (CAE) activities including modeling and simulation
  • Construction of prototype molds
  • Prototype part production runs to test and validate new or improved products or processes
  • Quality assurance activities related to new or improved parts or manufacturing processes
  • Process improvement projects to improve part quality such as surface finishes, etc.
  • Experimenting with the use of new raw materials or formulations
  • The design and development of new equipment or machinery, or improvements to existing equipment or machinery that result in increased uptime, improved quality, and reduced cycle-times
SOFTWARE DEVELOPMENT
Qualified activities may include:
  • The design and development of new or improved software applications, modules, features, or functionality
  • The development of functional specifications
  • The design and development of the software architecture
  • Software programming and code development
  • The testing and evaluation of new or improved software components
TELECOMMUNICATIONS
Qualified activities may include:
  • Project management; salaries of employees and contractors who manage eligible projects can be claimed for credit purposes
  • Bandwidth modeling projects, software, and labor costs may be eligible
  • Software design and development related to products or processes that are new and innovative
  • Product testing in a lab or field setting should be reviewed for a potential claim
VIDEO GAME DEVELOPMENT
Qualified activities may include:
  • Concept ideation, wire framing, and story-boarding.
  • The development of functional specifications and design requirements for new games.
  • The design and development of new game engines, or the development of software solutions to integrate new or improved game engines.
  • Experimentation with physics and other rules-based environmental algorithms.
  • Experimentation with the rendering and processing of graphics for 3D immersive world experiences and the development of techniques for the optimization of the display.
  • The development and integration of expansion packs.
  • The design and development for the processing of communications and interactions to support on-line games with multi-player modes.
  • Development of techniques and methods to leverage the capabilities and maximize the performance of hardware systems.
  • The design and development of the underlying software architectures.
  • Programming and software code development, specifically alpha and beta prototype development and testing.
  • The development of test cases for functionality and performance analysis.
  • Design, prototype development and testing of cabinets, enclosures, and accessories for arcade-style games.

FAQs

Does my company qualify for the R&D tax credit?

The simple answer is that if a company has projects which meet the requirements of IRC Code Section 41, they will generate expenses which qualify for the tax credit.

The research tax credit is entirely dependent on qualifying projects, and quantifying the allowable expenses associated with those qualified projects. As a result, any company can qualify, but to determine if they actually do require an evaluation of the facts and circumstances of their projects.

Under the expanded coverage introduced in the PATH Act, companies with average revenues of less than $50 million over the past three years may use credits to offset the Alternative Minimum Tax and newer companies with under $5 million in gross receipts may be eligible to offset some payrull tax obligations.

What is the audit risk?

The IRS has included the research tax credit on its  "Dirty Dozen" list of tax scams.

As a result, it is imperative to ensure that qualified expenses have been properly quantified, and that documentation is properly prepared to support the credit position taken.

The research credit is said to be incremental. What does this mean?

When Congress established the research credit, their intention was to encourage companies to increase spending on technological development. To accomplish this goal, a base amount was included in the calculation of the tax credit. The base amount serves as a hurdle or minimum amount that qualified expenses must exceed in order to generate a credit.

My company receives payments from customers for development projects. Do we still qualify for the research tax credit?

Congress intended that to qualify for the research tax credit, the taxpayer must bear the financial burden of the research. As a result, funded research is specifically disallowed from the research tax credit.

However, a funded research project could still qualify for the tax credit if the taxpayer is bearing the financial burden for the research. There is a two-part test to determine if the taxpayer is bearing the financial burden of the research. First, if payments are contingent on the success of the project, the research is considered not funded. Second, research is considered not funded if the taxpayer retains any substantial rights to the results of the research. Both requirements must be met for the research to be considered not funded.

Making a determination on funded research is a case-by-case decision based on a review of the terms and conditions of the contract or agreement.

What are the documentation requirements for the research tax credit?

Unfortunately there are no explicit guidelines for documentation required to support the research credit. The only guidance available is that taxpayers are required to retain sufficient documentation to support the credit claimed.

Typical recommendations for documentation would include project files that demonstrate how projects meet the qualification requirements, documentation that links employees to their involvement on qualified projects, and documentation supporting the base amount calculation.

I was not aware of the scope of R&D tax credit opportunities in the past. Is there a way to claim expenses from prior years?

Yes. If we conduct a review and find eligible activities, Tri-Merit can work with you to prepare an amended return for up to three previous filings.

My company was launched in the last few years and has not yet reached profitability. Are we eligible for R&D tax credits?

Potentially. A Qualified Small Business (QSB) with less than $5M in gross receipts may offset a portion of their payroll taxes if valid criteria are met.