By: Ryan Vaughan, Tax Director, Mazars USA LLP
One of the common misconceptions surrounding the R&D tax credit is that participants must wear lab coats and use test tubes in order to qualify. This could not be further from the truth – the definition of R&D for tax credit purposes is actually fairly broad. Companies are able to qualify activities from the development of concepts to the point where a product, process, formula, or other business component is ready to be commercially released. Amounts paid for salaries, supplies, contract research, and computer leasing could all qualify for the R&D tax credit. Moreover, a majority of US states have their own R&D credit programs.
Recent changes to the tax law have had a significant impact on the R&D tax credit:
- The Tax Cuts and Jobs Act (TCJA) reduced the top corporate tax rate to 21%, creating an opportunity for taxpayers making the reduced credit election under section 280C(c)(3) to recognize 79% of the R&D credit, versus 65% of the credit previously. Additionally, the repeal of corporate alternative minimum tax (AMT) expanded the availability for corporate taxpayers to utilize the R&D credit. The ability to consume the R&D tax credit was also expanded through the NOL limitation imposed by the TCJA, which limits the amount of taxable income prior year NOLs can offset to 80%, creating taxable income.
- The PATH Act permanently extended the R&D tax credit. It also made two very important changes effective for tax years beginning after December 31, 2015, which are intended to expand the reach of the credit. First, the legislation allows small businesses (with gross receipts under $50 million) to take the R&D tax credit against their AMT liability for tax years beginning after December 31, 2015. The AMT restriction has long prevented qualified companies from utilizing the R&D tax credit; the legislation removed that hurdle for eligible small businesses (ESB), defined below. Additionally, the PATH Act allows startup businesses with no federal tax liability and gross receipts of less than $5 million to take the R&D tax credit against their payroll taxes for tax years beginning after December 31, 2015, essentially making it a refundable credit capped at $250,000 for up to five years.
Regardless of industry, size, or revenue, any company that performs activities that meet the following four tests may qualify for R&D tax credits:
- Qualified Purpose. The purpose of the activity is to create a new or improved product or process (computer software included) that results in increased performance, function, reliability, or quality.
- Technological in Nature. The process of experimentation relies on the hard sciences, such as engineering, physics, chemistry, biology, or computer science.
- Technical Uncertainty. The activity is performed to eliminate technical uncertainty about the development or improvement of a product or process, which includes computer software, techniques, formulas, and inventions.
- Process of Experimentation. The activities include some process of experimentation undertaken to eliminate or resolve a technical uncertainty. This process involves an evaluation of alternative solutions or approaches and is performed through modeling, simulation, systematic trial and error, or other methods.
Common examples of activities potentially qualifying for the R&D credit are:
- New product development
- New process development
- Product redesign (new raw materials, ergonomics, operational improvements)
- Packaging design and testing
- Durability testing
- Process improvements (reduction of scrap, increased throughput, automation, tools and dies)
- Environmental changes (green manufacturing, reduction of emissions)
- Software development (automation, internet of things, app development)
If a company is engaged in any of these activities looking into a potential R&D tax credit may be a fruitful exercise. Please contact Ryan Vaughan, Tax Director, at 815.418.2486 or firstname.lastname@example.org.