How to Take Advantage of the R&D Tax Credit

How to Take Advantage of the R&D Tax Credit

In December 2010, President Obama signed into law the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, which extended the research and development (R&D) tax credit to apply to amounts paid and incurred between December 31, 2009 and January 1, 2012. Tax credits exist to encourage additional activity in a particular area, above and beyond what would have occurred without the tax credit. In this post, Stone Carlie will examine who and what expenses can qualify for the R&D tax credit.

Who qualifies for the R & D tax credit? To qualify, companies must have research and/or development activities that pass a four part test:

The development activities must be intended to discover information that would alleviate uncertainty. The uncertainty must relate to the development or improvement of a business component.

The discovery of information must be technical in nature. The discovery must be intended to gain information new to the taxpayer and is not freely available to the public.

The research must involve a process of experimentation. To engage in a process of experimentation, the development or design activities must involve a process of evaluating one or more alternatives, designed to achieve a result where the capability or the method of achieving that result is uncertain at the outset.

The research must create or enhance a business component. The purpose of the project can either create or enhance a business component's functions, performance, reliability, quality, or to significantly reduce its cost.

Which expenses qualify for the credit? Costs that are eligible for the research credit are called Qualified Research Expenses (QREs), which are specifically defined in IRC 174. For the sake of the tax credit, the most common expenses are in-house wages and supplies attributable to the qualified research; 65% of contract research expenses (paid to outside contractors in the U.S. whom are conducting qualified research on the taxpayer's behalf); and supplies directly used in the conduct of the qualified research.

What does this mean for your company? While this tax credit can be beneficial to your business, the IRS Commissioner has identified research credit refund claims as a top compliance issue and designated the R&D credit as a Tier I Issue. In other words, the IRS is going to scrutinize R&D credits more thoroughly. This increase in IRS audits relating to the R&D tax credit further emphasizes the importance of good recordkeeping. Read our most recent newsletter that focuses on the R&D documentation requirements necessary and how taxpayers can best prepare for an IRS audit.

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