In our guest blog this week Smith Miller, the CEO of Strategic Tax Solutions, provides clarification about the significant tax and cash flow benefits that businesses may enjoy by taking advantage of the often misunderstood and overlooked area of Research and Development tax credits.
In these tough economic times, business owners may be struggling to stay in the black. Businesses need all the help they can get to be profitable. An untapped source of revenue, oftentimes overlooked by CPAs for their clients, is the Research & Development Tax Credit, which encourages U.S. businesses to invest in improvements that increase their competitive position in the market. This is an enormous opportunity for an immediate source of cash, as well as a reduction to current and future years’ federal and state tax liabilities.
Due to the complex and technical nature of qualifying, quantifying, documenting and substantiating the R&D Tax Credits, CPA firms are working with R&D firms similar to Strategic Tax Solutions to uncover the opportunities to maximize their client’s tax savings through federal and state tax credits and incentives.
Unfortunately, many businesses don’t know that they qualify for R&D Tax Credits, which could possibly add up to millions of dollars in savings. Companies can recover cash for many activities they conduct on a day-to-day basis. The R&D Tax Credit has several advantages: it allows businesses access to an immediate source of significant cash for funding growth by monetizing R&D expenses, it can lead to permanent tax savings and is a vehicle to achieve additional tax savings in the future, and it also allows a reduction to the overall effective tax rate and an increase in cash flow and earnings.
Although R&D Tax Credits have been around since 1981, the rules were very stringent and only companies such as Microsoft and Boeing qualified for the Credits. Enacted by the Reagan Administration in a “Temporary Status,” the purpose was to provide incentives to develop innovative products and processes new to the world. Historically, R&D Tax Credits were targeted to patentable concepts and activities, which prompted only the most technologically sophisticated companies to apply for the Credits.
In 2001, as an economic stimulus incentive, President Bush made significant changes, which were finalized in 2003. Two major alterations were: the discovery test and documentation technical requirements were removed and the program was opened to small and medium size businesses. Now approximately 60 to 80 industries are eligible for R&D Tax Credits that encompass a wide variety of activities, which surprises many CPAs.
The R&D Tax Credit is a government-sponsored economic incentive backed by Congress and the administration. In addition to the federal credit, many states including California also offer R&D Tax Credit incentives, which generally conform to the federal tax credit guidelines. The R&D Tax Credit can provide a reduction to past, current and future federal and state tax liabilities. This becomes an immediate source of money for clients. The Credit differs from a deduction in that it is an actual dollar-for-dollar offset against taxes owed or paid. The credit is a source of permanent tax savings and can be claimed for all open tax years. If the credits cannot be used in a particular year, they are carried back one year and then carried forward up to 20 years for federal credits and indefinitely for California credits. Qualifying companies can retroactively claim R&D tax credits.
Some Industries that qualify for the R&D Tax Credit include:
Apparel Manufacturing
Architectural Services
Bio Fuel Cogeneration
Chemical Manufacturing
Component Manufacturing
Design Build Contractors
Electrical Contractors
Engineering Services
Environmental Services
Equipment Manufacturing
Food Manufacturing
General Contractors
Green Technology
Metal Stamping
Musical Equipment Manufacturing
Parts Manufacturing
Plastic Injection Molders
Software Developers
Solar & Photovoltaic (PV) Industry
Specialty Equipment Manufacturing
Tool, Die, Mold Manufacturing
The Tax Credit is derived from qualifying expenses in three major categories:
Salaries and wages, which are calculated and estimated as a percentage of employees’ qualifying time and can include those performing the qualified activity, those supervising the activity and those supporting the activity;
Supplies costs, which are consumed or destroyed during the qualifying activities; and
Contractor fees, where the rules are similar to salaries and wages.
The Credit is applicable when a new business component is developed or an existing business component is improved. Generally, a business component can be a product or a process, and can include any one of the following:
Manufacturing products
Developing prototypes or models (including computer generated models)
Designing tools, jigs, molds and dies
Developing or applying for patents
Conducting tests of new concepts and technology
Developing and introducing new technology
Attempting the use of new materials and compounds
Adding new equipment (labor and engineering cost aspects)
Automating and/or streamlining internal processes
Developing, implementing or upgrading systems and/or software
Developing production control software
Improving or building new manufacturing facilities
Expending resources on outside consultants/contractors to do any of the above activities
Activities that do not qualify for the R&D Tax Credit include:
Market Research
Non-retention of substantial rights
Research conducted outside the United States
Research related to management techniques
Research related to style of consumer taste
Reverse engineering
Patents are one of the best documents to support the application of R&D Credits. Other documents include:
Advanced testing documents or images
Contract review
Engineering notes or sketches
Lists or logs detailing innovation and/or new products
Meeting minutes
New product development
Process improvement discussions
Project time records
Schematics, diagrams or charts
There are four statutory criteria for an R&D Tax Credit:
1 The first is the permitted process. The activity must relate to a new or improved product or process intended to improve function, performance, reliability or quality.
2 The second criterion is the technological nature of the activity, which must fundamentally rely on the principles of physical, biological or computer science, or engineering.
3 The third criterion is the elimination of uncertainty. The activity must be intended to discover information to eliminate uncertainty related to capability of a product or process, method of a product or process or appropriateness of a product design.
4 The final criterion is a process of experimentation. Substantially all of the activities must relate to a process of experimentation involving evaluating alternatives, confirming the hypotheses through trial and error, testing and/or modeling, or refining or discarding of the hypothesis.
In summary, keep in mind that R&D Tax Credits are no longer for large companies in the technology sector. Each year thousands of small and medium size businesses in a variety of industries receive millions of dollars in cash from the R&D Tax Credit Program for a wide range of activities that improve their competitiveness. This is a great opportunity for business owners to take advantage of the R&D Tax Credits savings now and well into the future.
Smith Miller, CEO of Strategic Tax Solutions, works with CPA Corporation’s clients to identify and then apply for the R&D Tax Credit. Strategic Tax Solutions can be reached at (916) 724-3974 or through their website at www.ststaxcredits.com.