In this installment of our non-traditional tax incentive series, we discuss the financial benefits of conducting research and development. Initially a temporary program in the 1980s, this tax credit was created to incentivize and reward companies that invest in research. The Protecting Americans from Tax Hikes Act of 2015 was officially passed into law as a permanent federal tax program.
Research and development does not exclusively apply to medical organizations conducting experiments to cure cancer or to an engineer inventing a driverless car. The government offers R&D credit to encourage businesses of all types to engage in innovation and change, not necessarily invent something revolutionary.
Several business industries can participate in R&D: manufacturing, engineering design, software, chemical and pharmaceutical. Examples of R&D efforts that the IRS qualifies are streamlining company processes, programming new software, developing cost-efficient solutions, and integrating new machinery or technology into existing assets.
How does it work?
The federal R&D tax credit, also known as the Research and Experimentation tax credit, was established to encourage private businesses to invest in innovation.
There are four criteria that R&D activities must achieve in order to qualify for tax credit:
- They address a technological hurdle.
- An applied or hard science, such as engineering, biology or computer science, was conducted.
- The project introduces a new or improved business component, such as equipment, software or technique.
- They must prove experimentation was conducted through a process of testing and evaluation.
The results of the research do not necessarily have to be successful. Companies merely have to demonstrate the efforts they made toward the study.
Is my company big enough to qualify?
While it’s normal for higher revenue corporations to conduct R&D because of their access to greater resources, small businesses and startups can also qualify for the R&D tax credit. The passing of the PATH Act encouraged small businesses to participate in R&D by allowing them to take the tax credit against their alternative minimum tax. Additionally, startup businesses with no federal tax liability and gross receipts of less than $5 million can now take the R&D tax credit against their payroll taxes, even if they pay no income tax.
What are the benefits?
Companies that claim R&D benefits can save $20,000 to $40,000 per year for every $1 million in annual payroll. One advantage is that companies can receive R&D benefits, with interest, for activities conducted up to three years prior, in addition to the current tax year.
If you think your business is eligible for research and development tax benefits, comment below or contact Ray Hodges today to see if you can reduce your taxes. Also, read our previous post about another non-traditional tax incentive: cost segregation studies. It’s your money, until you give it away!