Are You Taking Advantage of The Research & Development Credit?
The Protecting Americans from Tax Hikes Act of 2015 (PATH Act) extended the expired Research & Development (R&D) credit retroactively to January 1, 2015. In addition to the extension, the credit was made permanent while also making two other significant changes described below.
Changes to the Research & Development Credit
Previously, a significant drawback of the R&D credit was that a company’s ability to use it was limited if the company or its shareholders/partners (in the case of pass-through entities) were subject to the Alternative Minimum Tax (AMT). The PATH Act now lets small businesses, with less than $50 million in average gross revenue over the prior three years, offset AMT with R&D credits generated after January 1, 2016. Furthermore, the shareholders/partners of pass-through entities that qualify as small businesses will also be able to offset AMT with R&D credits generated after January 1, 2016.
In addition, “Qualified Small Businesses,” which have less than $5 million in annual gross receipts and gross receipts for no more than five years, will now be able to use the R&D credit to offset the FICA employer portion of payroll tax. The amount of credit that can be used to offset payroll tax is capped at $250,000 for each eligible year.
The R&D credit can be claimed for qualified research expenses conducted as a part of a taxpayer’s trade or business. A brief summary of the R&D requirements are provided below.
Qualified research is research and development in the experimental sense that meets the following tests:
- Substantially all of the research must contain elements of a process of experimentation relating to a new or improved function, performance, reliability or quality.
- The research must be undertaken to discover information that is technological in nature i.e. it must rely on the principles of the physical, biological, engineering or computer sciences.
- The activity must be intended to discover information to eliminate uncertainty with developing or improving a product or process, or the appropriateness of the product design.
- The activities must include a process of experimentation through trial and error involving the evaluation of alternatives, testing/modeling, and confirmation or discarding of hypotheses.
Qualified Research Expenses
The following categories of expenses are eligible for the credit:
- Wages spent doing research, as well as supporting or supervising research activities. The term “wages” includes base wages, direct bonuses, nonqualified stock options, etc. If an employee does both qualified and non-qualified activities, only the qualified wages would be considered.
- Amounts paid for supplies used to conduct qualified research.
- Contract research expenses are also eligible up to 65% of the amounts paid to outside contractors.
Take advantage of this tax planning opportunity
With the updates to the R&D credit most qualifying companies can count on claiming the research credit when they plan for their research and development projects. And many businesses may have eligible R&D activity they are unware of. Consult with one of our tax advisers to discuss developing a plan that maximizes the benefits allowed under the new law.
Durkhanai Jan (DJ), CPA joined Dennis, Gartland & Niergarth in 2015 as a Tax Manager. She focuses on planning and tax services for business and individual clients at DGN. She had 10 years of public accounting experience prior to joining DGN providing tax planning and consulting services in addition to tax compliance. DJ is a member of the American Institute of CPAs and Michigan Association of CPAs. She earned a Master/Bachelor of Science in Accounting from Eastern Michigan University.