R&E Tax Credit Rewards Investment in Innovation

International companies doing business in the United States - particularly in southeast Michigan - are often looking to take advantage of the significant engineering talent here or are interesting in adapting current products for customers in the US.

Often these activities involve significant investment in research and experimentation (R&E), and now there's good news for companies with these types of expenditures.

As part of 2008's $700 billion rescue package for the financial markets, the US government also renewed and extended the federal R&E tax credit through 2009.

First introduced in the 1980s, the R&E tax credit is a tax-free refund that rewards companies for investing in process or product innovation. The credit can be as high as 6.5% of the qualified research expenses paid or incurred for a tax year in excess of the taxpayer's base amount for that year. While it is not a permanent part of the Internal Revenue Code, the popular R&E tax credit has been around for so long that its yearly legislative renewal is generally expected by companies and lawmakers alike.

To qualify for the credit, a company's R&E activities must meet four criteria:

  1. The activity on which the money is spent must be designed to create a new or improved product or process
  2. The research must be technological in nature
  3. Activities must be intended to eliminate uncertainty by discovering information that is currently unknown
  4. Activities must include a "process" to evaluate alternatives

Qualified research expenses include the W-2 wages for employees directly performing, supervising or supporting R&E services, along with supplies, contract research and software used in the conduct of qualified research. Note that, effective in 2008, the State of Michigan also provides a tax credit for qualified research.

Retroactive & Carry-Forward Credits

Undertaking a current year study is a good way to determine if a company is entitled to a credit and if so, to what degree. The R&E tax credit can be carried back for three years, allowing companies to claim credits generated in the past and helping them establish a baseline for moving forward. It is not unusual for companies to receive significant refund checks from the US Treasury for past R&E credits.

Unused credits can be carried forward for 20 years, which is especially helpful for companies that have generated credits but have not used them because they have not been in a position that required tax payments.

Because a R&E tax credit can involve a substantial refund, the IRS tends to pay special attention to R&E tax credit claims. However, companies with R&E claims should not be discouraged. Because of changes in the code over the past few years, more companies qualify for these valuable credits than ever before.

The key to success is to file for the credit in an appropriate way, building sound claims that allow the company to take full advantage of the credit. Because of the complexities involved, companies often turn to an outside resource to help them navigate the claim and audit processes. To ensure that R&E studies and filings are performed to the correct standards, it is important to work with a highly qualified service provider with experience in this specific arena.

What Qualifies?

The R&E Tax Credit covers a variety of activities, including:

  • New product development
  • Government-funded projects
  • Certification testing
  • Production process enhancements
  • Process automation
  • Creation of new manufacturing tools
  • Redesign of existing products
  • New materials testing
  • Production control software development
  • Outsourcing of research activities
  • Conceptual design testing
  • Development of new technology

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