The Credit for Increasing Research Activities, also known as the Research & Experimentation (R&E) tax credit, is one of the most prominent federal tax credits available to businesses.The purpose of the Credit for Increasing Research Activities is to invest in research that leads to new ideas, discoveries, and knowledge that will help to support a growing economy. In particular, the purpose of the R&E tax credit is to increase investment in research and experimentation activities. In my opinion, it is one of the most valuable federal tax credits that can be obtained. It has been claimed by a significant number of companies, ranging from small software startups, to multinational pharmaceutical firms, and many in between.
The R&E credit was initially introduced in 1981, and temporarily extended 16 times before becoming permanent under the Protecting Americans from Tax Hikes (“PATH”) act of 2015
How do I obtain the R&E Credit?
The credit can be claimed for the current tax year as well as retroactively for all open tax years.
Qualified research activities must meet a four-part test:
- Purpose of the activity or project must be to create new (or improve existing) functionality, performance, reliability, or quality of a business component
- Attempt to eliminate uncertainty concerning the development or improvement of the business component
- Included in a systematic experimentation process
- Be technological in nature (generally related to physical/biological sciences, engineering, or computer science)
Types of expenses that are usually included in the R&E credit:
- Contract Research – amounts paid to third parties for R&E activities (included at 65% of actual expense for the credit calculation)
It is important to keep adequate records and proper documentation for the R&E expenses.
Use of the R&E Credit
The use of the R&E credit can be helpful in offsetting what can be one of the largest expenditures for certain businesses. It was originally intended for businesses that fit the more traditional definition of research. For example, businesses operating in the medical and defense industries. Due to recent updates the credit is available to businesses in a variety of industries ranging from manufacturing to professional services.
At DKB we have seen many of our clients benefit from this credit. To show the significance of the credit I have outlined two case study examples below.
|Case Study #1||Case Study #2|
|Client||Startup medical device company in its first year of operations||Business developing a new piece of software|
|R&E Expense(s)||Incurred total R&E expenses of around $200,000 paid to 3rd parties, as well as $50,000 of wages and $100,000 of supplies||Paid $1.5 million to third parties for R&E work in 2016|
|Credit(s) Received||This resulted in a credit of nearly $30,000
The client had no taxable income in its first year and was able to reduce its payroll tax liability by the $30,000 credit
|This resulted in a credit of about $65,000 that the partners of the business can use to offset their federal tax liability|
Activities Not Qualified for Credit
While the R&E credit is valuable to businesses it is important to note that some activities that may seem like they fall under the R&E umbrella, do not.
Summarized listing of activities that do not qualify for the R&E tax credit:
- Research after commercial production
- Adaptation of existing business components
- Duplication of existing business component
- Surveys, studies, etc.
- Computer software – depending on the use
- Foreign Research
- Funded Research
- Research in the social sciences field
To learn more about the use of the R&E tax credit and if your business qualifies contact a member of our tax team today.