Research & Experimentation Tax Credit Update
The R&E tax credit (it used to be called the research and development, or R&D, credit) was originally established in 1981 as a temporary credit designed to increase R&D spending. Since then, it has expired and been extended 11 times, with the most recent extension through December 31, 2005.
While the credit was scheduled to expire at the end of 2005, history would suggest that it will be extended again, most likely in the spring of 2006. In the meantime, the best strategy is to make sure you've captured eligible credits from prior years. The credit is retroactive, so you can go back to any open year and amend your tax return to recapture lost credits.
You may now be able to claim the R&E tax credit if your company:
- Develops new or improved products, prototypes, or patents
- Possesses any trade secrets or proprietary information
- Modifies production processes
- Employs technical personnel on an employee or contract basis
- Evaluates new materials, compounds, or components
- Designs new manufacturing facilities
- Automates processes or develops sophisticated software
Meeting the Qualifications
Qualified research activities for the purpose of the R&E tax credit must meet four separate criteria. Note that each business component (e.g., product, process, formula, invention, or technique) must meet the following criteria:
- New or improved business component - The activity must be designed to create a new or improved product or process. While it doesn't have to be brand new to the marketplace, it must be new in terms of function, performance, reliability, or quality
- Technological in nature - The activity must be undertaken for the purpose of discovering information that is technological in nature. While the research doesn't have to be laboratory-based, it must fundamentally rely on the principles of physical or biological science, engineering, or computer science. The research cannot be in a "soft" science such as psychology
- Elimination of uncertainty - Activities must be intended to discover information that is currently unknown about how to improve or develop the product or process. Even if the outcome is unsuccessful, related activities can still qualify
- Process of experimentation - Activities must include a "process" to evaluate alternatives. This may involve developing a hypothesis and then testing, refining, or eliminating it through modeling, simulation, or trial and error
Internal-use software must also pass an additional three-part test: It must be commercially unavailable, pass a high threshold of innovation, and pose significant economic risk.
This credit can be quite lucrative. If you feel this may apply to you, or you have further questions, contact Robert Dutkiewicz at 248.208.8860.
R&E Credit Success Story
How does a rapidly growing technology company get to the next level? At the start, they had bootstrapped themselves, then struggled, and are now making money. With the Research & Experimentation credits we helped them claim from prior years, their effective tax rate dropped from a top rate of 34 percent to 8 percent. From here on, the tax rate will probably be approximately 25 percent. Those are some nice adjustments for a growing business.
