The R&D Credit – It’s Not Just for Tech Companies!
Originally published on October 17, 2016
Updated on August 16th, 2022
In late 2015, the long-standing (but temporary) research and development tax credit was made permanent with the passage of the Protecting Americans from Tax Hikes (PATH) Act. While start-up and small tech companies are often thought of as the primary targets of this credit, manufacturing companies have many opportunities to benefit as well.
The goal of the R&D credit is to reward companies for investment in developing new or improved products and processes. These efforts in turn foster innovation and promote long-term technological advances and economic growth – which will be critical in addressing a widening employee skills gap, balancing capacity with demand and other challenges faced by the manufacturing industry.
Benefits of the R&D tax credit can come in the form of a reduction in your tax rate and/or liability, improved cash flow, increase in earnings per share, and more. With the 2016 tax return season just about underway, now is the time to get started.
What can be classified as R&D?
Essentially, R&D encompasses work that results in improved products or processes to the extent that these improvements are new to the market or industry. Experimenting with new technologies and materials, designing new products, and research to discover new knowledge are all examples of R&D. The work must also have a general business purpose, as opposed to research performed merely out of curiosity.
There are many instances to which the R&D tax credit can be applied, including:
- The development of improved or second-generation products
- The innovation of new manufacturing equipment and tools
- Designing and evaluating new processes
- Increasing manufacturing and production capabilities
- Alternative material testing
- Prototyping and three-dimensional modeling
- Obtaining a patent (including attorney’s fees spent to improve the patent application)
According to the IRS, these expenditures must be “reasonable costs you incur in your trade or business for activities intended to provide information to help eliminate uncertainty about the development or improvement of a product.” Expenditures that do not qualify for the credit include:
- Quality control testing
- Advertising or promotions
- Consumer surveys
- Efficiency surveys
- Management studies
- Research in connection with literary, historical or similar projects
- The acquisition of another’s patent, model, production or process
How do I get started?
You’ll need to gather documentation that demonstrates how your company’s work and/or purchases fill the qualifications of R&D as specified by this provision. The key is to provide documentation proving that the work being claimed is actually based in research and development (this proof is often called a “nexus” by tax professionals). This can include minutes from meetings, email exchanges, and other communications that show your intent.
As with many tax credits, qualifications for the R&D credit payroll offset are subject to interpretation. Using these credits can also open you up for scrutiny by the IRS. So be to contact your tax accountant with any questions you have about how to use of this credit and determine eligible work. He or she can also explain to you the different ways in which you can take advantage of the credit (current-year deduction, amortization, etc.).
Laying the groundwork to take advantage of the R&D credit might seem daunting at first and will take a bit of time. But the benefits can make a huge difference to your bottom line.
All content provided in this article is for informational purposes only. Matters discussed in this article are subject to change. For up-to-date information on this subject please contact a James Moore professional. James Moore will not be held responsible for any claim, loss, damage or inconvenience caused as a result of any information within these pages or any information accessed through this site.
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