The Federal Government provides tax benefits to companies developing new products or methods to produce products. One such benefit is a tax credit available to companies who are spending money on qualifying research expenses related to such innovation. Section 41 of the Code provides a tax credit that is based on a taxpayer’s spending on “qualified research.” This research must satisfy the §174 definition of “research and experimental” to be considered qualified research. The research credit is more than “product” development costs in a traditional sense, and should be considered for other development costs (e.g., the costs of developing manufacturing processes). However, §41(d) provides that qualified research includes research for the purpose of developing new or improved “business components” which includes products, processes, computer software, techniques, formulas, and inventions, whether held for sale or lease by the taxpayer or used in the taxpayer’s trade or business. Successful development is not required.
The credit is available for both in-house (wages and supplies) and contract costs – qualified research expenses (or “QREs”) incurred by the taxpayer in conducting qualified research. The Code provides a detailed definition of qualified research; but, simply stated, it consists of research and development activities involving a process of experimentation designed to discover new information intended to develop a new or improved business component. Various exclusions are applicable as well. One of the most important aspects of claiming this credit is for the taxpayer to properly retain the documentation to support the qualified activities that occurred. This is a vital and extremely important step that must be done to sustain the credit.
The research credit calculation is determined a couple of different ways with the current computational method being the taxpayer’s most beneficial choice, elected on a timely, originally filed tax return. The research credit is currently available only through to December 31, 2009. Some bills are in process to have the research credit extended a 14th time in the past 28 years. The current thought is that this credit will be extended again. Furthermore, President Obama proposed in the FY2011 budget to make the research credit permanent.
It is important to work with the right professionals to guide you through the process of determining the appropriate amount of research tax credit to claim. Much abuse of the credit has taken place over the recent years and has led to increased scrutiny by the IRS. If calculated, documented, and claimed properly within the tax law, the research tax credit can be a very powerful tax tool for innovating companies.
