Explanation of the Credit

The R&E tax credit has been in existence since 1981, but recent regulations have relaxed the definition of qualified research activities and the record keeping requirements.  Consequently, many companies that were not eligible in the past may now take advantage of this federal tax credit.  Furthermore, the changes to the governing regulations are retro-active, meaning companies may file amended tax returns to obtain refunds of previously paid income taxes.  In some cases, companies may recapture taxes paid up to four years ago.
 

The R&E tax credit is a wage-based tax credit available for the development or improvement of products, processes, techniques, formulas, inventions or software.  In addition to R&E wages, companies may capture supply costs for prototypes, as well as 65 percent of contracted labor used during the development process.  This tax credit is available to all entities filing a federal tax return.  In addition, several states offer a modified R&E tax credit.

Companies can benefit by both deducting the research expenditures and by claiming the credit.  While the research expenditures are a reduction of taxable income, the R&E tax credit is a dollar-for-dollar reduction of tax.  In addition, any fees paid to advisors for documenting the credit are deductible in the year paid.

The R&E credit is calculated by comparing recent years’ research activities to a base amount with 20 percent of the increase in activities captured as the tax credit.

Companies must first use the credit to offset tax for the year the credit is generated.  However, if additional credit remains, the company may carry the credit back one previous tax year or forward to the next 20 years.

REQUIREMENTS

There are four basic requirements for research activities to qualify:

1. Qualified research activities are defined as the development or improvement to a business component, which is defined as a product, process, technique, formula, invention or software.
   
2. The research must be technological in nature.  That is, the process of experimentation used to discover the information fundamentally relies upon the physical or biological sciences, engineering or computer science.  Furthermore, companies may use existing technologies and may rely upon existing principles to satisfy this requirement.
   
3. The research must be intended to eliminate uncertainty concerning the development or improvement of a business component.  Uncertainty exists if the capability or method for developing the business component is unknown, or if the appropriate design of the business component is unknown.
Elimination of the technical uncertainty must be accomplished through a process of experimentation, including systematic trial and error, modeling or simulation.

For more details, call 866.961.EDGE(3343).