In mid-September, President Obama proposed expanding the research and development of a tax credit that was first enacted in 1981 – and making the benefit permanent. The provision, which has been extended some 13 times since 1981, provides companies that perform technological research with tax breaks on the cost of payroll, supplies for research workers and on 65 percent of the costs for paying contractors, as long as all the work performed is U.S. based.
Could your business be eligible for the R&D credit? Even if you haven’t considered this possibility before, why not think about it now? To qualify, the research undertaken must be technological in nature and involve new methods to improve or develop new products or processes. Here are some factors and questions to consider.
- You don’t have to be a rocket scientist to qualify. If your business is based on scientific principles (e.g. environmental cleanup, remediation, recycling processes, heating and air conditioning, etc.), you might qualify for the R&D tax credit.
- The exemption covers new or improved products or processes – a very general definition – but bear in mind your backup documentation to support your exemption claim must be very specific.
- Can you document the project(s) undertaken as R&D in appropriate detail?
- Do you have good documentation to date? Review what’s on hand with your project leader. If more thorough reporting is needed, implement the necessary procedures now.
- Can you identify employee and out-of-pocket costs and expenses specifically earmarked and spent on R&D?
- Can you determine how much you are spending on qualifying projects, and if they meet the IRS’ benchmarks? Currently the IRS accepts two ways of measuring R&D expenditure, though the president has proposed changes to simplify the calculation and potentially encourage more companies to seek the credits.
If this looks like it might work to your advantage, don’t wait until tax season is upon us. Confer with your professional tax advisor now to determine if your business might be eligible for the credit. If it is, your tax professional can determine the best way to generate the records and data needed to support your claim. He or she can also help you modify your existing accounting procedures to make the identification of R&D costs simpler when filing time comes around. Project-based accounting procedures are generally more helpful than cost-center based systems.
Your tax professional can also explain how the IRS determines if you are spending enough to qualify for a credit. The older and more complicated way of calculating overall R&D expenditures requires looking at expenses as a percentage of revenue over a period of time. The simpler method – and the one supported by President Obama – involves developing an average R&D expenditure over a three-year period, determining a base amount and calculating the tax credit on how much was spent above that base amount. The simpler calculation Obama proposes would provide a better return for most businesses. Don’t worry if you don’t have a three-year track record, as there are ways for startups to get R&D tax credits, too. Consult your tax advisor for more information.