On Thursday, May 21st, 2015, the House approved a permanent extension of the Research and Development Tax Credit. This credit has proven to be very popular over the years and has been historically included in the year-end extenders package. The passage contained no additional revenue offsets to recoup the costs of making it permanent, and the bill still has to go through the Senate and get signed by the President.
The Research and Development Credit, formally known as the “Credit for Increasing Research Activities,” was first put into the Internal Revenue Code in 1981 and has been extended over fifteen times. The credit provides firms with a tax credit offset related to costs to develop a new product or service. The credit as a whole is intended to spur innovation in the US. In order to be considered “qualified research,” there is a four-part test that needs to be met:
- The purpose of the project must be to create new or improve existing functionality, performance or quality of a business component, meaning a product or technique.
- There must be an elimination of uncertainty – the expenditures must improve the information available to the taxpayer with regards to the capability, method, or appropriateness of the business component.
- There must be a process of experimentation – the taxpayer must evaluate one or more alternatives with regard to the elimination of uncertainty. This can be something as rigorous as a full scientific method, or as simple as trial and error.
- There must be something technological in nature – the processes must rely on sciences such as engineering, biology sciences, or computer sciences.
In order to prevent abuse, there are numerous exclusions to the credit, including projects already in commercial production, adaptations and duplications, certain forms of internal-use software, and quality control and management techniques.
Generally speaking, there are three types of eligible expenses:
- Contract research
A taxpayer does not need to have sales in order to claim the credit, meaning startups in early years can take the credits in anticipation of future profits, and carry forward the credits to offset future taxes. These expenses are also not considered startup expenses required to be capitalized.
Edward McWilliams, CPA
Ed is a Partner in the firm’s tax and business advisory practice focusing on providing services to middle market private companies across different industries as well as to early stage startups. Ed has over a decade of experience providing tax and business consulting services to these companies of different sizes and across different industries, bringing a broad and diverse knowledge base and strategic solutions to the many complex issues that businesses face.