After intense negotiations, the President and Congress agreed to the passage of the American Taxpayer Relief Act of 2012. One of the key business provisions within this long awaited Act is the assurance that the Federal Research and Experimental Credit, originally set to expire in 2011, will be extended for years 2012 and 2013.
This credit, which is in addition to the tax deduction for research expenses and results in a dollar-for-dollar reduction of income tax liability, is often misunderstood and as a result, many businesses may be overlooking significant tax benefits. Because of confusion on what research is qualified and how the credit is computed, many small and medium size companies have not considered the credit and are missing out on benefits.
The two year window is a lengthy period of time for business to plan for this program. The Tax Credit and Incentive Group at Marcum would like to provide a summary of the rules and to assure you that many businesses are eligible for this benefit.
What is the research tax credit?
The credit, originally enacted during 1981, offers a financial incentive to U.S. companies that are engaged in certain types of product development and process engineering activities. Research qualifying for this credit program must:
- Be aimed at the development of a new or improved product or process. (Includes all technical activities such as analysis, design, developing, coding, testing, etc.)
- Be technical in nature.
- Rely upon some sort of process of experimentation which can involve the evaluation of alternatives and trial and error.
What expenses are eligible for the credit?
The credit is based primarily on wages and compensation and can include in-house salaries and wages of employees engaged in qualified research, as well as the costs of materials and supplies and 65% of amounts paid to third-party contractors for conducting qualified research. These expenses are known as qualified research expenses or QREs.
How is the research credit computed?
Companies may elect one of the two formulas used to compute the research credit:
1) the traditional credit and
2) the alternative simplified credit ("ASC").
Each alternative has specific computations and limitations and benefit specific types of taxpayers. The actual credit is based on various percentages of total qualifying expenditures.
How should the credit be documented?
Documentation is key for supporting the research credit. It is imperative for businesses to clearly and completely demonstrate to the Internal Revenue Service that the project expenses were indeed qualified research. Without proper documentation, upon examination, the credit claim will not be sustained. Proper documentation can include:
- Materials explaining the research activities,
- Project summaries,
- Progress reports,
- Minutes of meetings,
- Contracts for research performed,
- Time sheets for those employees involved in research,
- Schedule of job descriptions.
Do the states offer a research credit?
In addition to the federal research credit, many states offer some form of research credit or other related incentives.
More information on state credit programs can be found on the Marcum LLP website.
Is your company a candidate for the research credit?
Since the credit has been extended for two years, many Marcum clients have been encouraged to implement multi-year Federal and State tax credit programs.
Many manufacturing companies, and entities operating in chemical, electronics, manufacturing, medical technology, pharmaceutical, and software industry sectors or technology firms are examples of businesses likely to have qualified research and eligible costs.
Some recent samples of successful Marcum engagements include:
- Product manufacturers,
- Software companies,
- Multiple contract manufacturers,
- Multiple medical product, software application and device companies, and
- Service companies with new application and analytics activities.
To learn more about R&D, how your business may benefit for this program and whether your state offers a research credit, please contact your Marcum Tax Advisor.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.