Posted by William Mehi on 07.22.20

In today’s economy it’s important to prioritize and continue research and development (R&D) throughout your company to reap the benefits in federal and state tax credits. Research and development is performing activities for the sole purpose of discovering or developing new products, improving existing products or developing new or improved processes of production. Continually reinvesting in your company’s R&D to stay ahead of your customer needs and expectations is important for your growth as well as the growth of our economy. R&D provides a platform for creativity and innovation to flourish and your company to stay relevant. The research and development (R&D) tax credit provides motivation for companies to advance innovation in the United States.

R&D Tax Credits

Federal research and development (R&D) tax credits can deliver an immediate and significant benefit to a company as a result of innovative activities. While the tax credit originally pertained to basic research expenses, such as those occurring in a laboratory setting, subsequent modifications have simplified the credit and made it available to a wider variety of businesses including manufacturers of cosmetics and sunscreen lotions.  Efforts made to design and develop new products and manufacturing processes for improved performance and efficiency in the sunscreen industry can qualify for R&D tax credits.

R&D tax credits can immediately benefit a company in several ways:

• A source of cash for reinvestment or other needs
• Significant reduction to current and future tax liabilities
• Credits may carry forward up to 20 years
• Offset Payroll Liability

The U.S. government wants small businesses to develop innovative solutions, and companies that step up and focus on R&D can enjoy substantial tax credits. It’s not only high-tech or life science companies with dedicated research departments that qualify for the R&D tax credit. Even businesses that don’t employ scientists or other traditional researchers can take advantage of this incentive. 

R&D Research Activities 

If your company has invested money, time and resources into activities that help improve a process, product, technique or formula, or contribute to the invention of a new process or product, you stand a good chance of qualifying for valuable R&D credits. Here are some common qualified research activities:

• Developing or designing new products, processes or formulas
• Developing a new manufacturing process
• Developing prototypes or models
• Environmental testing
• Certification testing
• Developing or improving software technologies
• Testing new materials or concepts
• Streamlining internal processes
• Maintaining laboratory equipment
• Developing internal software solutions 
• Documenting research activities
• Designing or evaluating product alternatives

Meeting the Four-Part Test

The R&D tax credit encourages certain research activities by reducing a company’s liabilities for spending money on that research. The credit is equal to a certain percentage of a business’ qualified research expense (QRE) in excess of a base amount. Expenses that qualify are more comprehensive than you may think. QREs can include the salaries of employees and supervisors who are conducting research, supplies and even some of the research that is contracted out. R&D tax credit eligibility largely depends on whether the work you are conducting meets the criteria established by the IRS in its four-part test:

1. Qualified Purpose - The purpose of the research must be to create a new or improved product, process, or formulation, resulting in increased performance, function, reliability or quality. 
2. Technological in Nature – The research must rely on principles of the hard sciences, such as engineering, physics, chemistry, biology or computer science. 
3. Elimination of Uncertainty – Activities must overcome some unknowns, such as uncertainty as to capability, optimal design, or optimal methodology. 
4. Process of Experimentation – Experimentation can be demonstrated through test batches, simulations, systematic trial and error, or other methods of evaluating alternatives to achieve a desired result. 

Find Out if Your Activities Qualify

The R&D tax credit can be a lucrative incentive for inventive new businesses and start-ups. Could you be claiming more from your R&D tax credit claim in these challenging times? To learn more about whether your industry and company activities meet the R&D four-part test, request our free assessment today.

Though calculating the R&D credit is not complicated, knowing which expenses qualify and whether you have the correct documentation to back them up, is more difficult for many small businesses. Your accountant or qualified R&D tax credit expert can help you determine whether your business activities meet the criteria of the test by conducting a tax credit study.

Maintaining or increasing our country's R&D effort is essential if the U.S. is to increase the rate of job productivity growth and improve American living standards by offering better products and processes.

Tax Point Advisors provides R&D tax credit study services and other specialty tax services to CPA firms and their clients throughout the U.S. To learn more about R&D tax credits from the experts at Tax Point Advisors, please call us at (800) 260-4138 or please leave us a message below.